INCOME  and  FEDERAL 
TAX  REPORTS 


BY 

JOHN  A.  CONLIN 

LECTURER  ON  INCOME  TAXES  AT 
NEW  YORK  UNIVERSITY  SCHOOL  OF 
COMMERCE,  ACCOUNTS  AND  FINANCE 


WITH  THE  COLLABORATION  OF 


HENRY     BRACH,    B.    C.    S. 

PUBLIC         ACCOUNTANT 

C.'   D.    EVERSFIELD,    B.   C.   S. 

INSTRUCTOR    IN    ACCOUNTING,    NEW    YORK    UNIVERSITY 

PRIMUS   E.  GODRIDGE,  B.  C.  S. 

ASSISTANT    TRUST    OFFICER,    BANKERS    TRUST    COMPANY 
INSTRUCTOR    IN    ACCOUNTING,    NEW    YORK    UNIVERSITY 

GEORGE    HAMILTON,   B.  C.  S. 

ASST.  STAFF  SECRETARY,  ALEXANDER  HAMILTON  INSTITUTE 
INSTRUCTOR    IN    ACCOUNTING.    NEW    YORK    UNIVERSITY 


SECOND  1918  EDITION 


prentice-hAll*,  Inc:'* 

NEW  YORK 


First  Edition 
February  9,  1918 


v 


ill 


d\ 


Second  Edition 
February  27,  1918 

Copyright,  1918,  by 
PRENTICE -HALL,  Inc. 

AU  rights  reserved. 


PREFACE 

"We  are  ready  to  pay  our  taxes,  if  only  somebody  will 
tell  us  how."  That  is  the  sentiment  of  every  American. 
To  tell  them  how,  is  the  purpose  of  this  book.  I  have 
kept  in  mind,  while  writing  this  book,  the  fact  that  the 
taxpayer  will  have  before  him  a  tax  blank  to  which  he 
will  be  required  to  transfer  information  contained  in 
his  books  of  account.  How  is  that  blank  to  be  filled  out? 
Why  are  the  questions  asked?  Definite,  concrete,  illus- 
trative answers  to  these  questions,  I  am  sure,  will  be 
welcome.  I  have  assumed  all  along — and  I  believe  my 
assumption  is  well-founded — that  the  taxpayers  of 
America  are  honest;  that  they  are  not  asking  to  evade 
taxes,  but  that,  on  the  other  hand,  they  are  anxious  not 
to  make  errors  that  will  subject  them  to  unnecessary 
tax  burdens. 

It  is  a  modern  American  characteristic  to  spend  lit- 
tle time  in  arguing  about  the  expediency  or  the  wisdom 
of  a  certain  measure,  when  it  appears  more  important 
to  get  some  kind  of  action  concerning  that  measure.  I 
should  have  had  little  patience  with  a  publisher  who 
asked  me  to  write  an  economic  treatise  on  the  income 
tax.  I  should  have  had  little  desire  to  undertake  the 
arduous  labor  of  compiling  this  book  had  I  not  felt  it  a 
patriotic  duty  to  do  what  I  could  to  bring  the  people  of 
the  country,  upon  whom  the  taxes  herein  described  are 
to  fall,  in  full  sympathy  with  the  law  and  the  adminis- 
tration of  the  law.    The  demands  of  the  moment  would 

ill 


iv  PREFACE 

have  led  me  to  a  sympathetic  treatment  of  the  tax  pro- 
gram of  the  government,  however  unjust  that  program 
may  have  seemed  to  some  persons  and  however  just 
their  complaints  may  have  seemed  to  me.  But  fortu- 
nately there  is  little  basis  for  complaint.  While  in  some 
cases  the  tax  rate  appears  to  be  high,  the  scheme  of  tax- 
ation merely  follows  the  time-honored  practice  of  "ap- 
portioning public  burdens  in  accordance  with  the  pre- 
sumed capacity  of  individuals,"  and  the  exigencies  of  the 
situation  demanded  that  every  individual  be  required  to 
contribute  to  his  utmost.  On  the  other  hand,  the  reach- 
ing down  of  the  government  to  the  incomes  of  those  in 
moderate  circumstances,  I  believe,  will  bear  its  reward  in 
habits  of  thrift  and  in  a  growing  sense  of  responsibility 
to  and  for  the  government,  and  these  rewards  will  more 
than  offset  the  temporary  small  sacrifice  that  the  tax 
laws  require. 

I  entered  upon  the  compiling  of  this  work  with 
enthusiasm  and  took  from  an  already  busy  life  every 
moment  possible  to  complete  the  book  within  time  to 
make  it  of  value  to  the  average  business  man.  I  must 
take  this  opportunity  to  thank  my  collaborators  heartily 
for  their  assistance — not  only  because  it  has  enabled  me 
to  accomplish  what  otherwise  would  have  been  an  im- 
possible task,  but  because  their  energy  and  enthusiasm 
prevented  my  own  spirit  from  weakening  under   the 

fatigue  of  unbroken  effort. 

John  A.  Conlin. 
New  Yobk  University, 
February  5,  1918. 


TABLE  OF  CONTENTS 


CHAPTEB  PAGE 

I.  INTRODUCTION     1 

II.  Administration   17 

III.  Individual  Income  Tax — Gross  Income  32 

IV.  Individual  Income  Tax — Deductions    99 

V.  Individual  Income  Tax — Rate  of  Tax 126 

VI.  Individual  Income  Tax — Returns  and  Computation  of 

Tax  138 

Vll.  Corporation  Income  Tax — Corporations  Subject  to  Tax  165 

VIII.  Corporation  Income  Tax — Gross  Income   180 

IX.  Corporation  Income  Tax — Deductions  206 

X.  Corporation  Income  Tax — Rate  and  Computation  of  Tax  252 

XI.  Withholding,  Deduction  and  Information  at  the  Source  258 

XII.  Fiduciaries   281 

XIII.  The  Income  Tax  Law 296 

XIV.  Capital  Stock  Tax 347 

XV.  The  Capital  Stock  Tax  Law  381 

XVI.  Federal  Estate  or  Inheritance  Tax 385 

XVII.  The  Federal  Estate  Tax  Law 422 

XVIII.  Munition  Manufacturer's  Tax 434 

XIX.  The  Munition  Manufacturer's  Tax  Law 451 

XX.  Occupational  Taxes  458 

XXI.  The  Occupational  Taxes  Law   471 

XXII.  War  Excise  Taxes  477 

XXIII.  The  War  Excise  Taxes    Law 488 

XXIV.  The  Tax  on  Beverages  Law 493 

XXV.  War  Stamp  Taxes   520 

XXVI.  The  War  Stamp  Taxes  Law 564 

XXVII.  War  Tax  on  Public  Utilities  and  Insurance 575 

XXVIII.  The  War  Tax  on  Public  Utilities  and  Insurance  Law  590 

XXIX.  War  Tax  on  Admissions  and  Dues 596 

XXX.  The  War  Tax  on  Admissions  and  Dues  Law 606 

XXXI.  Collection  Districts   609 

XXXII.  The  War  Excess  Profits  Tax  Law   625 

XXXIII.  War  Excess   Profits  Tax    639 

Index 


INCOME 

AND 

FEDERAL  TAX  REPORTS 

CHAPTER  I 
INTRODUCTION 

The  tax  program  of  1918  based  on  precedent.  —  The 
federal  government  has  been  fortunate  in  being  brought 
into  the  great  European  conflict  with  reasonable 
notice.  We  have  had  time  to  inquire  into  the  finan- 
cial expedients  of  our  previous  wars.  Moreover,  we 
have  had  the  experience  of  Great  Britain  and  France 
through  three  years  of  extreme  stress  to  guide  us.  Fi- 
nally, we  have  had  our  difficulties  pile  up  before  us 
gradually,  so  that  our  people  and  our  businesses  have 
not  been  suddenly  thrust  into  a  period  of  heavy  tax 
burdens,  but  have  had  time  and  opportunity  gradually 
to  put  themselves  on  a  war  basis. 

It  is  a  notable  fact  that  there  is  practically  nothing 
new  in  the  present  tax  program.  The  excess  profits  tax 
is  a  modern  expedient,  but  we  borrowed  that  from  Eng- 
land. The  other  taxes  were  used  in  one  form  or  an- 
other in  the  Civil  War. 

Civil  War  taxes. — While  most  readers  will  be  inter- 
ested in  the  1918  war  taxes  only  to  know  how  they  must 
be  met,  there  will  be  many  who  will  take  a  broader  in- 
terest and  who  will  be  ready  to  inquire  how  those  taxes 
happened  to  come  about.  As  we  have  already  indicated, 
for  most  of  the  forms  of  special  taxes  that  are  now  be- 
ing levied  there  is  a  precedent,  in  the  taxes  which  were 
imposed  to  meet  the  demands  of  the  Civil  War.    Con- 

1 


2  INCOME    AND    FEDERAL    TAX   REPORTS 

gress  levied  estate  taxes,  special  taxes  on  liquors,  on 
articles  of  common  use  and  on  luxuries  such  as  car- 
riages and  yachts.  There  were  stamp  taxes  and  income 
taxes,  occupation  taxes  on  financial  institutions,  and  on 
advertisements.  There  appears,  however,  to  have  been 
no  precedent  for  the  excess  profits  tax,  the  tax  on  ad- 
missions to  places  of  amusements  and  no  tax  on  the 
mail. 

History  of  Income  Taxes. — Of  all  the  taxes  enacted  dur- 
ing the  Civil  War  the  most  interesting  was  the  income 
tax.  The  original  act  of  August  5,  1861,  levied  a  tax 
of  3  per  cent  on  incomes  over  $800.  The  exemption 
was  later,  September  1,  1862,  reduced  to  $600.  Incomes 
received  from  obligations  of  the  United  States  were 
taxed  IY2  per  cent.  Citizens  living  abroad  were  taxed 
at  the  rate  of  5  per  cent.  Supertaxes  of  5  per  cent  were 
levied  on  incomes  in  excess  of  $10,000.  The  law  was 
several  times  amended,  and  finally  expired  by  limita- 
tion at  the  end  of  1871.  It  is  to  be  credited  with  rais- 
ing $376,290,600.56  for  the  government,  and  drew  in- 
come tax  from  276,661  persons. 

In  1894  Congress  adopted  another  income  tax,  but  it 
was  held  unconstitutional ■  in  the  following  year  on  the 
ground  that  it  was  a  direct  tax,  and  was  not,  in  pur- 
suance to  the  federal  constitution,  apportioned  among 
the  States.  Moreover,  it  was  objectionable,  since  it  did 
not  exempt  the  interest  on  State  and  municipal  bonds. 
In  1909  Congress,  in  spite  of  this  decision,  enacted  what 
was  in  effect  an  income  tax  on  corporations,  but  the  Su- 
preme Court  validated  it  by  calling  it  an  excise  on  cor- 
porations, assessed  "with  respect  to"  incomes.  In  1913 
the  doubt  about  the  validity  of  federal  income  taxes 
was  ended  with  the  ratification  of  the  Sixteenth  Amend- 
ment to  the  Federal  Constitution,  which  provides :  "The 
Congress  shall  have  power  to  lay  and  collect  taxes  on 
incomes,  from  whatever  source  derived,  without  appor- 

1  Pollock  v.  Farmers'  Loan  and  Trust  Co.  (157  U.  S.  429;  158  U.  S.  601). 


INTRODUCTION  3 

tionment  among  the  several  States,  and  without  regard 
to  any  census  or  enumeration."  Finally,  in  1916,  the 
Supreme  Court  stated  "that  taxation  on  income  was  in 
its  nature  an  excise,"  and  therefore  valid  without  the 
aid  of  the  sixteenth  amendment. 

The  Income  Tax  of  1909. — The  tax  of  1909  was  a  tax 
on  corporations  only,  but  the  word  corporations  in- 
cluded joint  stock  companies  or  associations  organized 
for  profit  and  having  a  capital  stock,  as  well  as  insur- 
ance companies,  organized  under  the  laws  of  the  United 
States.  Foreign  corporations  were  also  liable  for  the 
tax,  which  was  applied  to  that  part  of  their  net  income 
which  was  earned  within  the  United  States.  Charitable 
institutions  were  expressly  exempted.  Net  income  was 
found  by  deducting  from  gross  income  (1)  operating 
and  maintenance  expenses,  including  rentals  and  fran- 
chise payments;  (2)  losses  not  compensated  by  insur- 
ance, including  reasonable  depreciation;  (3)  interest  on 
bonded  indebtedness  to  an  amount  not  exceeding  the 
amount  of  issued  stocks,  and  interest  on  deposits,  when 
paid  by  banks;  (4)  all  taxes  of  a  State  or  of  the  United 
States  and  all  foreign  taxes  imposed  as  a  condition  of 
carrying  on  business  in  foreign  countries;  and  (5)  the 
amount  received  as  dividends  from  other  companies  sub- 
ject to  the  tax.  Reports  were  due  on  the  first  of  March 
covering  the  income  of  the  previous  calendar  year,  and 
the  tax  at  the  rate  of  1  per  cent  upon  the  entire  net  in- 
come over  and  above  $5,000  was  due  on  June  30.  Pen- 
alties were  provided  for  breaches  of  the  law. 

The  1909  law  is  now  of  historical  interest  only — the 
present  law  does  not  in  any  way  refer  to  it,  as  it  does 
to  the  true  Income  Tax  laws  of  1913  and  1916. 

The  Income  Tax  of  1913. — This  law  was  enacted  Octo- 
ber 3,  1913.  It  was  not  intended  as  a  temporary  meas- 
ure, but  was  intended  to  bring  revenues  to  the  govern- 
ment, which  had  quite  definitely  abandoned  its  almost 
sole  reliance  for  revenues  on  import  duties. 


4  INCOME   AND    FEDERAL    TAX   REPORTS 

The  law  of  1913,  popularly  known  as  the  Underwood 
Tariff  Bill,  was  the  first  valid  income  tax  law  since  the 
Civil  War.  It  applied  to  individuals  as  well  as  to  cor- 
porations. Corporations  were  taxed  upon  their  entire 
net  income,  without  the  benefit  of  the  exemption 
of  dividends  received  from  another  corporation  also 
subject  to  the  tax.  Partnerships  were  to  return  their 
income  only  in  case  the  Internal  Eevenue  Department 
required  such  returns  to  check  up  the  returns  of  their 
several  partners.  Besides  an  exemption  of  $3,000  for 
single  persons  and  $4,000  for  married  persons,  there 
were  deducted  from  the  gross  income  to  find  the  taxable 
net  income  (1)  expenses  of  carrying  on  any  business, 
(2)  interest  paid  on  personal  indebtedness,  (3)  all  State 
and  local  taxes  paid,  (4)  losses  not  compensated  by 
insurance,  (5)  uncollectible  debts  charged  off,  (6)  a  rea- 
sonable allowance  for  depreciation,  (7)  a  credit  of  divi- 
dends received  from  corporations  paying  the  tax,  (8) 
and  income  upon  which  the  tax  had  been  collected  at 
the  source.  Interest  received  from  public  securities 
and  salaries  of  State  and  local  officials  were  specifically 
exempted.  The  normal  rate  was  one  per  cent.  Super- 
taxes were  levied  on  incomes  over  $20,000.  A  novel 
feature  of  the  tax  was  the  English  expedient  of  collec- 
tion at  the  source,  by  which  is  meant  that  all  persons 
or  corporations  paying  to  individuals  income  in  the  form 
of  wages,  interest,  rent  or  the  like  in  excess  of  $3,000 
or  $4,000  were  required  to  deduct  the  one  per  cent  tax 
and  pay  it  over  to  the  collector. 

The  Income  Tax  of  1916. — On  September  8,  1916,  the 
law  of  1913  was  repealed  and  a  new  income  tax  law 
was  enacted.  The  1916  law  is  still  in  effect,  though  it 
has  been  amended  and  supplemented  by  the  "War  Rev- 
enue law  of  October  3,  1917.  It  is  unnecessary  at  this 
place  to  give  even  a  summary  of  the  law  of  1916,  for  it 
is  described  at  length  in  the  pages  that  follow;  but  for 
the  sake  of  continuing  the  outline  unbroken,  we  shall 


INTRODUCTION  5 

indicate  a  few  of  the  changes  that  were  made  in  the  law 
of  1913.  The  normal  tax  was  raised  from  1  per  cent 
to  2  per  cent,  and  the  surtax  was  increased  from  a 
maximum  of  6  per  cent  (on  incomes  over  $500,000)  to 
a  maximum  of  13  per  cent  (on  incomes  over  $2,000,000). 
The  other  principal  change  was  the  extension  of  the 
$4,000  exemption  from  married  persons  to  the  "head 
of  a  family."  Deductions  were  also  allowed  for  taxes 
paid  in  foreign  countries  and  for  certain  kinds  of  losses, 
including  thefts,  and  allowances  were  made  for  actual 
depletion  of  natural  resources;  these  deductions  and 
allowances  had  not  been  recognized  under  the  law  of 
1913.  The  Treasury  Department  extended  all  its  rul- 
ings under  the  1913  act,  as  far  as  applicable  to  the 
1916  act. 

The  income  tax  provisions  of  the  1917  War  Revenue  Law. 
— The  1917  War  Tax  Law  was  approved  October  3, 
1917.  It  amended  the  1916  law  in  certain  respects  but 
did  not  repeal  it.  It  also  added  new  extra  taxes  on  in- 
come for  war  purposes.  In  effect,  then,  there  is  now 
a  double  tax  on  income,  although  it  is  calculated  from  a 
single  return.  Indeed,  from  this  single  return  four 
amounts  will  have  to  be  calculated:  (1)  the  normal  tax 
of  2  per  cent  under  the  1916  act;  (2)  the  normal  tax  of 
2  per  cent  under  the  1917  act;  (3)  the  supertaxes  un- 
der the  1916  act;  and  (4)  the  supertaxes  under  the  1917 
law.  The  normal  tax  under  the  1917  law  is  not  to  be 
collected  at  the  source,  though  this  provision  still  re- 
mains in  part  as  to  the  normal  tax  under  the  1916  law. 
Further  discussion  of  the  details  of  the  income  tax 
features  of  the  War  Revenue  Act  of  1917  is  reserved 
to  the  chapters  dealing  with  the  individual  and  corpora- 
tion income  tax  reports. 

Other  war  taxes  in  general. — The  acts  of  1909  and  1913 
were  enacted  before  the  European  war  broke  out.  The 
revenues  designed  to  be  raised  from  them  had  nothing 
to  do  with  a  preparedness  program.     But  the  act  of 


6  INCOME    AND    FEDERAL    TAX    REPORTS 

1916  was  a  step  toward  preparedness  and  was  intended 
to  yield  large  revenues.  For  this  reason  it  raised  the 
normal  and  supertax  rates.  But  it  added  other  features 
besides  the  income  tax  to  the  federal  taxing  system. 
Indeed,  it  had  been  preceded,  on  October  22,  1914,  by  a 
War  Kevenue  Law,  which  laid  a  special  tax  on  bankers, 
brokers,  commercial  brokers,  commission  merchants, 
custom-house  brokers,  pawn-brokers,  theater,  museum 
and  concert  halls,  circuses  and  other  public  exhibitions, 
bowling  alleys  and  billiard  rooms  and  on  tobacco  manu- 
facturers and  dealers.  This  law  of  1914  also  provided 
stamp  taxes  on  promissory  notes,  legal  and  other  in- 
struments, on  perfumery,  cosmetics  and  chewing  gum, 
and  on  liquors  and  wines. 

The  law  of  1916  made  several  changes  in  the  act  of 
October  23,  1914,  and  contained  provisions  intended  to 
aid  certain  industries.  Among  the  latter  is  the  increased 
import  duty  on  dyestuffs. 

The  Estates  Tax. — One  of  the  most  important  taxes 
added  to  the  act  of  1916  (the  other  was  the  munitions 
tax)  was  the  so-called  Estates  Tax.  Inheritance  taxes 
were  used  to  finance  the  Civil  War.  It  was  proposed 
to  include  another  such  tax  in  the  tariff  law  of  1909, 
but  the  States  felt  that  the  federal  government  should 
not  take  away  an  established  source  of  State  income, 
and  their  objections  were  heeded.  By  1916  the  needs  of 
the  federal  government,  however,  had  become  so  great 
that  little  difficulty  was  found  in  introducing  the  estates 
tax  provisions  into  the  law  of  1916.  They  provide  for  a 
tax  on  the  transfer  of  the  entire  estate,  the  tax  being 
based  on  the  net  estate,  calculated  by  deducting  from 
the  gross  estate,  debts,  administrative  expenses,  losses 
and  the  like,  and  also  an  exemption  of  $50,000  for  resi- 
dents of  the  United  States.  The  tax  applies  to  the  es- 
tate of  every  decedent  whether  a  resident  of  the  United 
States  or  not.  Exemption  is  not,  but  deductions  are  al- 
lowed on  the  estates  of  non-residents  in  proportion  to 


INTRODUCTION  7 

the  parts  of  the  estates  that  were  situated  within  the 
United  States,  but  his  provision  is  conditioned  upon 
receipt  of  full  information  by  the  government. 

On  March  3,  1917,  the  Estates  Tax  law  was  amended. 
The  rates  were  raised,  and  they  were  again  raised  by 
the  War  Tax  Act  of  October  3,  1917.  Under  the  pres- 
ent scheme  the  rates  of  the  September  8,  1916,  act  have 
been  increased  by  those  of  the  act  of  March  3,  1917, 
and  these  latter  are  still  in  effect,  but  have  been  added 
to  by  the  rates  imposed  by  the  act  of  October  3,  1917. 
The  rates  in  the  three  acts  are  as  follows: 


Act  of 

Act  of 

Act  of 

March  3, 

Oct.  3, 

Total 
Rate 

Estate 

Sept.  8, 

1917, 

1917, 

1917 

Addi- 

Addi- 

tional 

tional 

Rates 

Rates 

% 

% 

% 

% 

Not  exceeding  $50,000 

1 

y* 

y2 

2 

Exceeding     $50,000  but  not    $150,000.. 

2 

i 

l 

4 

"             150,000    *      "       250,000.. 

3 

i^ 

W* 

6 

"             250,000    "      u       450,000.  . 

4 

2 

2 

8 

"             450,000    "      "     1,000,000.. 

5 

2^ 

2^ 

10 

"          1,000,000    "      u    2,000,000.. 

6 

3 

3 

12 

"          2,000,000    "      *    3,000,000.. 

7 

33^ 

3^ 

14 

«          3,000,000    "      "    4,000,000.  . 

8 

4 

4 

16 

4,000,000    "      "    5,000,000.. 

9 

4^ 

4^ 

18 

"          5,000,000    "      "    8,000,000.  . 

10 

5 

5 

20 

"          8,000,000    u      "  10,000,000.  . 

10 

5 

7 

22 

"        10,000,000 

10 

5 

10 

25 

The  estates  tax  as  it  now  stands  is  to  run  indefi- 
nitely, but  will  probably  be  repealed  after  the  war. 
The  additional  tax  of  October  3,  1917,  is  not  to  be  im- 
posed on  the  estates  of  those  dying  while  serving  in  the 
military  or  naval  forces  of  the  United  States  during 
the  present  war,  or  within  one  year  after  its  close,  if 
death  results  from  injuries  or  disease  contracted  in  the 
service. 

The  Munitions  Tax. — The  Munition  Manufacturers' 
Tax  was  enacted  as  a  part  of  the  War  Eevenue  Act  of 
September  8,  1916.     It  followed,  in  its  purposes,  the 


8  INCOME    AND    FEDERAL    TAX   REPORTS 

somewhat  similar  taxes  of  Sweden  and  Denmark  among 
the  neutrals,  and  of  Great  Britain,  France,  Italy  and 
Germany  among  the  combatants.  It  was  originally  re- 
stricted to  a  period  ending  one  year  after  the  close  of 
the  European  war.  The  latest  act,  that  of  October  3, 
1917,  reduced  the  tax  from  twelve  per  cent  to  ten  per 
cent  upon  net  profits  for  the  year  1917,  and  provided 
that  the  tax  should  cease  on  and  after  January  1,  1918. 

Capital  Stock  Tax. — In  place  of  the  tax  of  one  dollar 
for  each  $1,000  of  capital  employed  by  banks — a  tax 
originating  in  the  law  of  October  22,  1914 — the  law  of 
September  8,  1916,  imposed  a  special  excise  tax  of  50 
cents  per  $1,000  of  fair  value  of  capital  stock  upon 
every  domestic  corporation,  insurance  company  or  asso- 
ciation having  a  capital  stock  represented  by  shares. 
The  legal  reserves  of  insurance  companies  are  not  to  be 
included  and  an  exemption  of  $99,000  is  allowed  each 
company.  Foreign  corporations  transacting  business 
within  the  United  States  are  also  subject  to  this  tax  at 
the  rate  of  50  cents  per  $1,000  of  capital  actually  em- 
ployed in  the  transaction  of  business  in  the  United 
States.  A  proportion  of  the  exemption  of  $99,000  is 
allowed  these  foreign  corporations,  measured  by  the 
ratio  of  capital  employed  within  the  United  States  to 
the  total  capital  invested.  Title  III  of  the  act  allows 
that  munition  manufacturers  are  not  to  be  subject  to 
the  provisions  of  this  act  and  those  of  the  Munitions 
Tax  law,  but  are  to  be  subject  to  the  tax  which  pro- 
vides the  greatest  revenue  to  the  government. 

Excess  Profits  Tax. — Of  the  various  laws  thus  far  men- 
tioned the  most  important  is  the  Income  Tax  law.  But 
the  most  important  tax,  from  the  standpoint  of  yield  to 
the  government,  is  the  Excess  Profits  tax.  This  tax  is 
expected  to  raise  no  less  than  $1,000,000,000.  The  Ex- 
cess Profits  tax  law  was  first  passed  in  March,  1917; 
under  the  provisions  of  this  act  profits  in  excess  of  8 
per  cent  on  invested  capital  were  taxed  at  the  rate  of 


INTRODUCTION  9 

8  per  cent.  It  will  be  seen  that  this  act  differed  radi- 
cally from  its  prototype,  the  English  Excess  Profits 
tax,  which  was  indeed  a  tax  on  excess  profits  caused 
by  the  war.  The  War  Tax  law  of  October,  1917,  made 
material  changes  in  the  Excess  Profits  tax.  As  the  law 
now  stands  the  basis  of  the  tax  is  to  be  found  in  the 
"pre-war"  period  of  1911-12-13.  If  the  profits  of  that 
period  amounted  to  less  than  7  per  cent  of  the  then 
invested  capital,  then  7  per  cent  of  the  capital  for  the 
taxable  year  is  deducted  from  the  net  profits  before  de- 
termining the  amount  of  taxable  net  profits.  If  the 
profits  of  the  pre-war  period  ranged  from  7  to  9  per 
cent,  then  the  actual  percentage  is  used  in  calculating 
the  proper  deduction,  but  if  profits  in  the  pre-war  pe- 
riod exceeded  9  per  cent,  then  9  per  cent  is  taken  as 
the  per  cent  of  allowable  untaxed  profits.  Profits  in 
excess  of  that  rate  are  taxable.  Extra  allowances  of 
$3,000  for  domestic  corporations  and  of  $6,000  for 
partnerships  and  individuals  are  made.  Further  dis- 
cussion is  reserved  for  the  chapter  devoted  specially  to 
this  tax. 

On  account  of  the  great  difficulty  that  has  been  ex- 
perienced in  drafting  and  interpreting  the  Excess 
Profits  Tax  Law,  we  have  added  the  following  descrip- 
tion of  the  English  method  of  computing  the  tax,  taken 
from  the  London  Economist,  November  27,  1915: 

"This  tax  is,  in  fact,  an  additional  income  tax  im- 
posed on  certain  trades  and  businesses,  not  upon  offi- 
cials, employees,  and  professional  men  who  are  exempt. 
But  any  business  man  or  agent  who  is  paid  partly  by 
commission  is  included,  except  commercial  travellers, 
who  are  specifically  excluded.  All  salaried  persons  are 
excluded,  whether  their  salaries  have  been  stationary 
or  not.  Clerks  working  overtime  or  persons  who  have 
changed  one  salaried  occupation  for  another  with 
higher  remuneration  escape  taxation.  If  a  small  por- 
tion of  the  income  is  received  by  way  of  commission, 


10  INCOME   AND   FEDERAL    TAX   REPORTS 

as  is  often  the  case  with  company  directors  or  mana- 
gers, such  persons,  according  to  Mr.  McKenna  (then 
Chancellor  of  the  Exchequer),  do  not  fall  within  the 
scope  of  the  Act,  because  they  do  not  'carry  on  a  busi- 
ness.' .  .  . 

"The  trades  and  business  liable  to  the  tax  include 
any  which  are  carried  on  in  the  United  Kingdom  or 
are  owned  or  carried  on  in  any  other  place  by  persons 
ordinarily  resident  in  the  United  Kingdom.  Any  busi- 
ness or  trade  to  which  the  tax  applies  is  liable  to  pay 
to  the  Exchequer  a  sum  equal  to  50  per  cent  of  the 
amount  by  which  the  profits  for  the  'accounting  period' 
exceed  by  more  than  £200  the  defined  pre-war  standard 
of  profits.  .  .  . 

"It  is  important  to  remember  that  the  tax  is  not  a 
tax  upon  war  profits  as  such,  nor  upon  high  profits 
earned  during  war  conditions,  but  upon  profits  enjoyed 
during  the  war  period.  .  .  . 

"The  computation  of  the  profits  of  the  'accounting 
period'  is  dealt  with  in  Part  1  of  the  Fourth  Schedule. 
The  profits  are  not  to  be  calculated  by  income  tax  rules, 
but  are  to  be  the  actual  profits  of  the*  period,  and  de- 
ductions will  be  allowed  for  interest  on  borrowed  money 
or  for  rent  or  royalties  or  other  payments  which  are 
excluded  under  the  Income  Tax  Acts,  because  income 
tax  on  them  is  collected  at  the  source.  On  the  other 
hand,  all  profits  or  gains  from  lands,  etc.,  forming  part 
of  the  assets  of  the  business,  which  are  excluded  under 
the  Income  Tax  Acts  because  they  are  taxed  under  a 
separate  schedule,  must  be  brought  into  the  excess 
profits  computation. 

"No  deductions  for  wear  and  tear  or  for  any  expen- 
diture of  a  capital  nature  for  renewals  are  allowed,  ex- 
cept such  as  may  be  allowed  under  the  Income  Tax 
Acts,  and  then  only  such  amounts  as  appears  to  the 
Commissioners  of  Inland  Eevenue  to  be  reasonable 
and  to  be  properly  attributable  to  the  year  or  account- 


INTRODUCTION  11 

ing  period.  Here  practice  is  to  be  based  upon  income 
tax  principles.  .  .  . 

"It  is  provided  that  without  special  reasons  the  sums 
allowed  as  remuneration  of  directors  and  managers 
may  not  exceed  the  sums  allowed  in  the  last  pre-war 
trade  year,  and  no  deduction  is  allowed  in  respect  of 
any  transaction  which  appears  to  have  artificially  re- 
duced the  amount  of  profits.  Any  transaction  already 
carried  through  which  would  have  this  effect  must  be 
disclosed  under  pain  of  severe  penalties.  In  the  Bill  as 
originally  drafted  power  was  given  to  the  Commission- 
ers to  examine  and  make  copies  of  books  of  account, 
but  this  was  expunged  in  Committee. 

"Excess  profits  are  to  be  determined  upon  the  basis 
of  a  pre-war  standard,  which  is  defined  as  the  average 
of  any  two  of  the  last  three  pre-war  trade  years;  the 
two  years  to  be  selected  by  the  taxpayer.  If  this 
amount  is  less  than  6  per  cent  upon  the  capital  at  the 
end  of  the  last  pre-war  year  in  the  case  of  a  company, 
or  7  per  cent  in  the  case  of  any  other  business,  the 
standard  profit  is  to  be  taken  as  equal  to  6  per  cent,  or 
7  per  cent,  as  the  case  may  be,  upon  that  capital,  and 
where  a  business  has  changed  hands  within  the  last 
three  pre-war  years  or  has  been  started  within  that 
period,  the  percentage  standard  is  to  be  adopted.  In- 
creases in  the  standard  percentage,  or  adjustments  in 
the  pre-war  profit  standard,  may  be  made  by  the  Board 
of  Eeferees  at  their  discretion.  Mr.  McKenna  evi- 
dently intended  the  Board  to  use  very  wide  latitude, 
for  he  stated  that  the  6  per  cent  allowance  upon  cap- 
ital would  be  ridiculous  in  the  case  of  rubber  plantation 
companies. 

"To  meet  the  case  of  trades  or  businesses  which  have 
been  unduly  depressed  during  the  past  three  years,  Mr. 
McKenna  introduced  an  amendment  on  November  22, 
1915,  which  provides  that  where  it  is  proved  to  the 
satisfaction  of  the  Commissioners  that  the  last  three 


12  INCOME   AND   FEDERAL    TAX   REPORTS 

pre-war  trade  years  were  years  of  abnormal  depres- 
sion, the  average  of  any  four  of  the  last  six  pre-war 
trade  years  may  be  substituted  as  the  pre-war  standard 
of  profits.  The  last  three  pre-war  trade  years  may  not 
be  considered  as  years  of  abnormal  depression  unless 
the  average  profits  of  those  years  have  been  at  least  25 
per  cent  lower  than  the  average  profits  of  the  preced- 
ing three  years. 

"The  manner  of  assessing  the  capital  is  dealt  with  in 
Part  3  of  the  Fourth  Schedule,  and  it  is  here  that  in- 
terpretation is  most  difficult.  Capital  is  defined  'so  far 
as  it  does  not  consist  of  money,'  as  (a)  the  price  at 
which  assets  acquired  by  purchase  were  purchased,  sub- 
ject to  any  proper  deductions  for  wear  and  tear  or  re- 
placement, or  for  unpaid  purchase  money;  (b)  debts 
due  to  the  trade  or  business,  subject  to  any  reduction 
which  has  been  allowed  in  respect  of  those  debts  for 
income  tax  purposes;  and  (c)  the  value  of  other  assets 
at  the  time  when  they  became  assets  subject  to  any 
deductions  for  wear  and  tear  or  replacement.  Any  cap- 
ital the  income  on  which  is  not  taken  into  account  in 
calculating  the  profits  (i.e.,  interest  on  investments  in 
the  case  of  companies  other  than  financial  companies), 
and  any  borrowed  money  or  debts  shall  be  deducted 
when  arriving  at  the  amount  of  capital  for  the  purpose 
of  the  percentage  standard  allowance. 

"The  value  to  be  attached  to  goodwill  stands  in  a 
very  curious  position.  If  a  company  is  assessed  upon 
the  pre-war  standard  basis,  goodwill  does  not  enter  into 
the  matter  at  all;  but  if  no  pre-war  standard  is  avail- 
able, the  basis  of  assessment  is  the  percentage  standard 
upon  capital.  Section  3  of  the  Fourth  Schedule  states 
that  where  any  asset  has  been  paid  for  otherwise  than 
in  cash  its  cost  price  shall  be  the  value  of  the  consid- 
eration at  the  time  the  asset  was  acquired.  But  where 
a  business  has  been  sold  to  a  company  and  the  consid- 
eration consisted  wholly  or  mainly  of  shares,  no  value 


INTRODUCTION  13 

shall  be  attached  to  those  shares  so  far  as  they  are  rep- 
resented by  goodwill,  or  otherwise  than  by  material  as- 
sets. This  will  apply  most  inequitably  to  concerns 
which  adopted  the  joint-stock  principle  shortly  before 
the  outbreak  of  war  and  acquired  a  really  valuable 
goodwill  in  exchange  for  shares.  A  private  banking 
business,  for  example,  generally  has  a  goodwill  more 
valuable  than  the  nominal  capital  of  the  business,  and 
if  turned  into  a  joint-stock  company  the  partners  gen- 
erally desire  to  retain  a  large  interest  in  the  business 
by  accepting  the  greater  part  of  their  purchase  price 
in  shares.  Under  the  excess  profits  proposals  the 
shares  issued  in  respect  of  goodwill  will  be  inadmis- 
sible as  capital." 

What  the  taxes  will  yield.1 — It  was  estimated  that  the 
war  taxes  would  yield  in  1918  about  $2,500,000,000,  as 

followS:  Millions 

Incomes,  individual  and  corporate 851.0 

Excess  profits   1,000.0 

Spirits,  liquors,  wines 193.0 

Soft  drinks,  syrups,  etc 13.0 

Tobacco,  and  manufactures  thereof  63.4 

Freight  transportation   77.5 

Express  transportation   10.8 

Passenger  transportation    60.0 

Pipe  lines 4.5 

Seats  and  berths 4.5 

Telegraph  and  telephone  messages 7.0 

Insurance     5.0 

Automobiles    40.0 

Musical  instruments,  etc 3.0 

i  Later  estimates  have  greatly  increased  this  amount,  and  now  the  gov- 
ernment expects  to  receive  $1,201,000,000  from  income  taxes  before  July  1, 
including  $666,000,000  from  individuals  and  $535,000,0ou  from  corpora- 
tions. This  is  more  than  one-third  of  the  $3,400,000,000  estimated  receipts 
under  the  War  Revenue  act  passed  by  Congress  at  the  last  session.  From 
excess  profits  taxes  the  Government  expects  to  realize  about  $1,220,000,000 
before  July  1. 


14  INCOME   AND   FEDERAL    TAX   REPORTS 

Millions 

Motion  picture  films 3.0 

Jewelry    4.5 

Sporting  goods   1.2 

Pleasure  boats  .5 

Perfumes  and  cosmetics 1.9 

Proprietary  medicines  3.4 

Chewing  gum  .4 

Cameras    .7 

Admissions    50.0 

Club  dues  1.5 

Stamp  taxes,  etc 9.0 

Estate  taxes   5.0 

First-class  mail  matter 70.0 

Second-class  mail  matter 6.0 

Munition  manufacturers'  tax 25.0 


2,514.8 

Income  tax  yields  of  previous  years. — The  following 
table  has  been  prepared  to  show  the  yields  to  the  gov- 
ernment of  the  tax  on  the  incomes  of  individuals: 

1913-14        1914-15         1915-16 
Rate         000  000  000 

per  cent    Omitted        Omitted        Omitted 

Normal  tax 1    $12,728    $16,500    $23,966 

Additional  tax  on  net  in- 
come of: 

$20,000  to   $50,000.  1  2,935  4,107  6,092 

50,000  to     75,000.  2  1,646  2,501  4,071 

75,000  to  100,000.  3  1,323  2,103  3,624 

100,000  to   250,000.  4  3,836  5,945  10,936 

250,000  to   500,000.  5  2,335  3,328  6,394 

Exceeding  $500,000  6  3,438  6,439  12,648 
Settlement  in  compro- 

14  63  183 


mise 


Total    28,254      41,046      67,944 


INTRODUCTION  15 

In  1917  the  collections  were  as  follows: 

Normal  tax  of  2  per  cent $55,742,230.89 

Additional  tax  on  net  income  of: 

$20,000  to    $200,000 36,363,894.44 

200,000  to      250,000 6,241,807.10 

250,000  to      300,000 5,196,876.88 

300,000  to      500,000 12,969,686.27 

500,000  to  1,000,000 14,501,213.51 

1,000,000  to  1,500,000 7,531,893.76 

1,500,000  to  2,000,000 4,888,040.10 

Exceeding  $2,000,000  16,145,856.30 

Settlements  in  compromise 15,994.50 

Total    $167,787,089.39 

In  comparing  the  year  1913-14  with  the  other  years 
it  must  be  remembered  that  the  tax  fell  on  the  income 
not  of  the  entire  year  but  of  ten  months  of  the  year 
1913  only. 

In  1913  only  357,598  persons  made  returns.  In  1917 
this  number  increased  to  437,036.  It  is  estimated  that 
with  the  decrease  in  the  non-taxable  exemption  from 
$3,000  and  $4,000  to  $1,000  and  $2,000  a  great  many 
more  people  will  file  returns,  the  aggregate  for  1918 
being  placed  at  6,350,000  persons. 

Summary. — In  a  statement  issued  October  5,  1917,  the 
Commissioner  of  Internal  Eevenue,  Daniel  C.  Roper, 
enumerated  the  persons  subject  to  the  new  tax  laws. 
The  statement  gives  the  following  list: 

All  individuals  receiving  incomes  of  more  than  $1,000 
or  $2,000  a  year. 

All  corporations,  joint-stock  companies  and  associa- 
tions. 

All  distillers,  rectifiers,  wholesalers  and  retailers, 
holders  of  distilled  spirits  intended  for  sale  or  to  be 
used  for  manufacturing  purposes. 

All  dealers  in  fermented  liquors  and  malt  liquors, 
wines,  cordials  and  liqueurs,  domestic  and  imported. 


16         INCOME   AND   FEDERAL    TAX   REPORTS 

All  dealers  in  soft  drinks,  table  waters  and  carbonic 
acid  gas. 

All  manufacturers  of  and  dealers  in  cigars,  cigarettes, 
tobacco,  snuff  and  cigarette  papers. 

All  carriers  of  freight,  express,  or  passengers,  and 
all  operators  of  pipe  lines. 

All  dealers  in  life,  marine,  inland,  fire  and  casualty 
insurance.  All  manufacturers  and  wholesale  dealers  in 
motor  vehicles  of  every  kind,  [certain  mechanical] 
musical  instruments,  motion  picture  films,  jewelry, 
boats,  sporting  goods,  perfumes,  cosmetics,  medicinal 
preparations,  chewing  gum  and  cameras. 

All  proprietors  of  amusement  places,  including  caba- 
rets. All  persons  executing  legal  documents  of  any  type. 

All  traders  on  produce  or  stock  exchanges  and  boards 
of  trade.     All  importers  of  merchandise. 

All  manufacturers  and  importers  of  playing  cards. 

Duty  of  persons  to  file  returns  and  pay  the  tax. — Every 
citizen  and  every  person  resident  in  the  United  States 
is  bound  to  make  a  return  if  his  income  is  over  $1,000 
or  $2,000,  as  the  case  may  be.  The  duty  of  citizens  was 
stated  by  Commissioner  Roper  as  follows: 

"Upon  every  citizen  rests  the  responsibility  of  con- 
tributing to  the  utmost  of  his  ability  toward  the  suc- 
cessful termination  of  the  war.  The  War  Revenue  Act 
represents  the  judgment  of  the  United  States  Congress 
as  to  what  is  the  proper  share  for  each  citizen  to  con- 
tribute. This  share  is  based  upon  the  ability  of  the 
citizen  to  contribute.  It  is  the  unquestioned  duty, 
therefore,  of  every  true  American  citizen  not  only  to 
pay  the  full  tax  the  law  requires  of  him,  but  to  remove 
every  possible  obstacle  to  the  successful  administration 
of  the  law  by  the  Bureau  of  Internal  Revenue.  In  the 
circumstances,  it  is  a  high  privilege  for  every  citizen 
to  comply  strictly  with  the  terms  of  the  law  and  to 
make  it  a  part  of  his  duty  to  see  that  every  other  citi- 
zen does  likewise." 


CHAPTER  II 
ADMINISTRATION 

Organization  of  the  Internal  Revenue  Bureau. — The  ad- 
ministration of  the  internal  revenue  laws  is  in  the  hands 
of  the  Bureau  of  Internal  Eevenue,  a  division  of  the 
Treasury  Department.  This  bureau,  which  is  now  under 
the  direction  of  Commissioner  of  Internal  Eevenue 
Daniel  C.  Roper,  is  charged  with  the  administration 
of  all  internal  revenue  laws  and  with  the  collection  of 
taxes  imposed  by  these  laws.  The  amount  of  taxes 
collected  by  this  bureau  has  increased  greatly  in  the 
past  four  years,  the  increase  being  due  almost  entirely 
to  the  enactment  of  the  Income  Tax  law.  The  new 
"war  taxes"  are  expected  to  result  in  such  an  increase 
in  the  amount  of  taxes  that  the  bureau  has  been  en- 
tirely reorganized  in  anticipation  of  its  great  task.  An 
idea  of  the  immensity  of  this  task  may  be  obtained  from 
the  fact  that  the  government's  estimate  of  the  amount 
of  internal  revenue  for  its  fiscal  year  ending  June  30, 
1918,  is  $3,500,000,000  as  compared  with  $750,000,000 
collected  for  the  fiscal  year  ended  June  30,  1917. 

The  Commissioner  of  Internal  Revenue  is  responsible 
to  the  financial  executive  of  the  country,  the  Secretary 
of  the  Treasury.  The  Secretary  has  called  to  the  Com- 
missioner's assistance  two  advisory  boards,  (1)  the 
Legal  Advisory  Board  and  (2)  the  Excess  Profits  Ad- 
visory Board. 

The  Legal  Advisory  Board  is  composed  of  a  number 
of  the  leading  lawyers  of  the  United  States.  This 
Board  will  advise  the  Treasury  Department  in  all  legal 

17 


18  INCOME   AND    FEDERAL    TAX    REPORTS 

matters  arising  through  the  enforcement  of  the  vari- 
ous tax  laws. 

The  members  of  the  Excess  Profits  Advisory  Board 
are:  Representative  Cordell  Hull,  a  member  of  the 
House  Committee  on  Ways  and  Means;  T.  S.  Adams, 
economist,  of  Yale  University;  Wallace  D.  Simmons, 
President,  Simmons  Hardware  Co.,  of  St.  Louis  and 
Philadelphia;  J.  E.  Sterret,  of  Price,  Waterhouse  & 
Co.,  accountants,  of  New  York  City;  S.  E.  Bertron,  of 
Bertron,  Griscom  &  Co.,  bankers,  of  New  York  City; 
E.  T.  Meredith,  of  Des  Moines,  Iowa,  editor  of  Suc- 
cessful Farming;  T.  W.  McCullough,  editor  of  the 
Omaha  Bee,  of  Omaha,  Nebr. ;  Stewart  W.  Cramer,  of 
the  National  Association  of  Cotton  Manufacturers, 
Charlotte,  N.  C,  and  Henry  Walters,  Chairman  of  the 
Board  of  the  Atlantic  Coast  Line  and  Louisville  & 
Nashville  Railways. 

In  announcing  the  appointment  of  the  Board,  Secre- 
tary McAdoo  said:  "The  Government  is  fortunate  in 
obtaining  as  advisors  men  of  such  broad  vision  and 
experience,  who  are  patriotically  interested  in  seeing 
that  the  money  so  vitally  needed  for  war  purposes  is 
collected  with  the  least  inconvenience  to  the  public  and 
to  business  generally." 

The  Internal  Revenue  Bureau  is  divided  into  six  di- 
visions, each  division  in  charge  of  a  deputy  commis- 
sioner or  supervisor. 

The  first  three  divisions  take  care  of  the  regulations 
regarding  the  collection  of  the  various  taxes.  The  In- 
come, Excess  Profits  and  Munitions  taxes  are  under  the 
supervision  of  one  deputy  commissioner.  The  Tobacco, 
Distilled  Spirits,  Capital  Stock,  and  Estate  taxes  form 
the  second  division,  the  third  division  covering  the 
Miscellaneous  and  Sales  taxes.  The  deputy  at  the  head 
of  each  division  is  charged  with  the  duty  of  making  all 
necessary  regulations  for  the  collection  of  the  taxes 
under  his   control.     The   regulations   issued  by   these 


ADMINISTRATION  19 

deputies  must  have  been  approved  by  the  Commis- 
sioner of  Internal  Revenue. 

The  fourth  department  has  charge  of  the  actual  col- 
lection of  the  tax.  The  head  of  this  division  has  the 
official  title  of  Supervisor  of  Collectors'  Offices,  and  is 
responsible  for  organization,  methods  and  personnel. 

The  fifth  division,  under  the  Chief  Revenue  Agent,  is 
in  charge  of  the  inspection  of  returns.  The  work  of 
this  department  in  seeing  that  the  taxes  are  paid  by 
every  one  subject  to  them  is  discussed  in  detail  later  in 
this  chapter. 

The  sixth  division  covers  an  entirely  new  phase  of 
governmental  activity.  The  creation  of  the  Division  of 
Business  Cooperation  is  a  recognition  of  the  fact  that 
the  taxpayer  as  well  as  the  government  is  interested 
in  the  methods  of  collecting  the  taxes.  The  work  of 
this  division  is  twofold;  it  is  to  act  as  an  educator  and 
also  as  an  adjuster.  It  is  estimated  that  7,000,000 
more  people  will  file  income  tax  returns  for  1917  than 
did  for  1916.  It  is  necessary,  therefore,  to  educate  the 
public  as  to  the  requirements  of  the  new  law.  The 
Division  of  Business  Cooperation  is  conducting  a  na- 
tional campaign  of  education,  cooperating  with  Cham- 
bers of  Commerce,  Boards  of  Trades,  manufacturers' 
organizations  and  other  volunteers.  The  second  func- 
tion of  the  Division  is  to  act  as  an  adjuster  between 
the  tax  payer  and  the  government.  All  complaints 
and  suggestions  for  improvements  in  the  operation  of 
the  law  will  be  handled  through  this  department. 

How  the  tax  laws  are  interpreted. — In  the  administra- 
tion of  the  internal  revenue  laws  by  the  Treasury  De- 
partment, the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury,  prepares 
sets  of  "Rulings"  covering  questions  of  interpretation 
and  administration  of  the  tax  law,  theretofore  enacted 
by  Congress.  These  rulings  are  given  a  number  and 
are  then  known  by  that  number.    The  last  general  com- 


20         IX  CO  ME   AND    FEDERAL    TAX    REPORTS 

pilation  of  rulings  on  the  Income  Tax  was  issued  on 
January  5,  1914,  and  is  known  as  Regulations  No.  33. 

From  time  to  time  the  Commissioner  of  Internal 
Eevenue  issues  formal  "Treasury  Decisions"  (the  so- 
called  "T.  D.'s").  These  have  the  approval  of  the  Sec- 
retary of  the  Treasury  and  serve  the  purpose  of  ex- 
plaining some  feature  of  the  regulations  or  of  the  law 
itself.  Besides  these  formal  rulings,  the  Department, 
in  answer  to  inquiries  made  by  collectors  or  by  taxpay- 
ers, usually  through  the  collectors,  gives  mimeographed 
rulings  or  opinions,  sometimes  referred  to  as  "Letters." 
These  letters  refer  to  matters  not  important  enough  to 
become  the  subject  of  a  formal  decision.  The  contents 
of  some  letters  are  given  to  the  public  and  are  taken 
into  account  in  the  explanation  of  various  matters  in 
this  book. 

Whenever  a  rule  or  regulation  is  issued  it  supersedes 
previous  rulings  on  the  same  subject.  The  Department 
has  the  power  to  make  these  rulings  retroactive,  since 
the  rulings  do  not  affect  the  law  but  merely  interpret 
it.  The  Department,  however,  has  in  several  cases  re- 
frained from  enforcing  its  ruling  retroactively  in  cases 
where  property  rights  would  be  affected  as  between  dif- 
ferent persons  or  groups  of  persons. 

Court  Decisions. — Other  decisions  which  affect  the  law 
are  the  interpretations  of  the  court.  If  a  taxpayer  is 
dissatisfied  with  the  ruling  of  the  department  he  may 
bring  an  action  in  one  of  the  District  Courts,  and  may 
appeal  from  the  decision  of  this  court  to  the  United 
States  Supreme  Court.  The  Department  ordinarily 
will  be  guided  by  the  decision  of  the  final  court,  but  of 
course  may  claim  that  the  facts  in  any  given  case  do 
not  fit  exactly  the  decision  in  the  previous  case.  The 
taxpayer  in  such  a  case  may  be  compelled  to  take  his 
case  to  the  court. 

How  the  law  will  be  construed. — The  main  purpose  of 
the  courts  in  deciding  any  case  is  to  discover  the  true 


ADMINISTRATION  21 

intent  of  the  legislature  and  then  give  to  the  law  such  an 
interpretation  as  will  carry  out  this  intent.  This  does 
not  mean  that  the  court  can  go  outside  the  law  itself, 
as,  for  example,  to  the  record  of  the  debate  contained 
in  the  Congressional  Eecord,  to  inquire  into  the  intent 
of  the  legislature.  The  intent  is  to  be  discovered  from 
the  use  of  the  words,  the  general  purpose  of  the  act, 
and  from  general  principles  of  justice.  While  the  law 
will  not  be  construed  strictly  in  favor  of  the  taxpayer, 
as  in  the  case  of  the  laws  relating  to  crimes,  the  benefit 
of  any  doubt  as  to  the  true  meaning  of  a  clause  will 
be  given  to  the  taxpayer.  The  courts,  of  course,  will 
rely  on  their  own  previous  opinions  when  applicable, 
and  will  even  give  weight  to  the  rulings  of  the  Treas- 
ury Department,  especially '  to  those  of  long  standing. 
The  court,  however,  will  always  make  an  independent 
inquiry  into  the  meaning  of  the  law  and  will  not  de- 
cide in  favor  of  a  Treasury  Department  ruling  which 
seems  clearly  contrary  to  the  meaning  of  the  law. 

Taxes  in  outlying  possessions. — Under  the  1916  law  the 
tax  applies  to  the  "United  States,"  which  is  construed, 
for  the  purpose  of  the  Income  Tax,  to  include  "the 
United  States,  any  Territory,  the  District  of  Columbia, 
Porto  Eico,  and  the  Philippine  Islands." 

A  resident  of  Porto  Rico  or  the  Philippine  Islands 
would  pay  the  taxes  in  those  Territories,  the  internal 
revenue  officers  of  which  are  given  power  to  administer 
the  law.  Under  the  amendments  contained  in  the  In- 
come Tax  law  of  October  3,  1917,  however,  the  several 
legislatures  of  those  Territories  are  given  the  right  to 
amend  or  repeal  the  Income  Tax  law  within  their  own 
boundaries,  and  inquiry  must  be  made  therefore  in  the 
respective  territories  concerning  what  action,  if  any, 
has  been  taken  by  the  local  legislatures  and  adminis- 
trative officers.  Residents  of  the  United  States,  how- 
ever, part  of  whose  income  is  derived  from  investments 
in    those    Territories,    should    include    such    income    in 


22  INCOME   AND    FEDERAL    TAX    REPORTS 

their  returns  and  pay  their  taxes  in  the  district  wherein 
they  reside. 

The  collection  of  the  income  and  excess  profits  taxes. — 
The  actual  collection  of  the  taxes  is  handled  by  the 
local  collectors  of  internal  revenue.  For  the  purpose 
of  tax  collection,  the  United  States  is  divided  into  64 
collection  districts,  each  district  being  in  charge  of  a 
collector  of  internal  revenue.  A  list  of  the  districts, 
with  the  names  and  addresses  of  collectors,  will  be 
found  in  the  appendix. 

Every  person,  firm  or  corporation  required  by  law  to 
file  a  return  for  any  tax  should  file  the  return  within 
the  required  time  with  the  collector  of  internal  revenue 
for  the  district  in  which  they  reside  or  have  their 
principal  place  of  business. 

When  a  return  is  filed  it  is  examined  to  see  if  it  is 
properly  prepared.  If  there  are  any  gross  errors  the 
return  may  be  sent  back  to  be  corrected.  If  a  new  re- 
turn is  made  out,  the  old  return,  showing  the  date  of 
its  receipt,  should  also  be  returned  to  the  collector  to 
avert  the  possibility  of  the  assessment  of  a  penalty  for 
failure  to  file  the  return  on  time.  The  amount  of  tax 
is  then  calculated  and  the  returns  are  listed  for  assess- 
ment on  what  is  known  as  the  monthly  list.  The  list 
and  returns  are  forwarded  to  the  Commissioner  of  In- 
ternal Revenue,  who  charges  the  local  collector  with 
the  total  amount  of  the  tax,  as  shown  by  the  list,  which 
is  then  returned  to  the  collector.  Upon  receipt  of  this 
list  the  collector  sends  each  person  or  organization  a 
bill  for  the  amount  of  tax  assessed  (Form  647  or  Form 
17).  The  tax  must  be  paid  by  a  date  fixed  by  law  or 
within  10  days  after  the  receipt  of  the  first  notice  and 
demand  (Form  17). 

Penalties. — The  law  imposes  various  penalties  for  fail- 
ure to  make  returns,  and  for  failure  to  pay  the  tax. 

For  failure  to  file  a  return  on  time,  except  in  case  of 
sickness  or  accident,  a  penalty  will  be  imposed  of  50 


ADMINISTRATION  23 

per  cent  in  addition  to  the  amount  of  the  tax.  If  a 
return  is  voluntarily  made,  without  notice  from  the  col- 
lector, and  it  is  shown  that  the  failure  to  file  was  due 
to  a  reasonable  cause  and  not  to  wilful  neglect,  the 
penalty  will  not  be  imposed. 

If  a  false  or  fraudulent  return  is  made,  a  penalty  of 
100  per  cent  of  the  amount  of  tax  will  be  imposed. 
This  penalty  of  100  per  cent  is  always  computed  upon 
the  amount  actually  due.  In  the  case  of  special  taxes, 
the  basis  on  which  the  100  per  cent  penalty  is  computed 
may  be  one  or  more  of  the  taxable  occupations  of  the 
taxpayer  not  disclosed  in  his  false  return,  or  an  addi- 
tional amount  for  the  same  occupation  not  disclosed  by 
the  false  return. 

For  failure  to  file  the  proper  returns  on  or  before 
March  1  of  each  year  an  individual  or  an  agent  is 
liable  to  a  specific  penalty  of  from  $20  to  $1,000,  but 
the  50  per  cent  penalties  for  failure  to  make  return 
will  not  be  assessed  against  delinquent  withholding 
agents.  Any  individual  or  any  officer  of  a  corporation 
required  to  make  or  verify  any  return  who  makes  an 
intentionally  fraudulent  return  is  guilty  of  a  misde- 
meanor and  is  subject  to  a  fine  not  exceeding  $2,000 
or  imprisonment,  or  both,  in  the  discretion  of  the  court, 
and  must  also  pay  the  cost  of  the  proceedings. 

If  any  corporation  refuses  or  neglects  to  file  a  re- 
turn in  time,  or  makes  a  false  or  fraudulent  return,  it 
is  liable  to  a  specific  penalty  of  not  exceeding  $10,000. 

On  any  taxes  remaining  unpaid  for  10  days  after  no- 
tice and  demand  by  the  collector  there  is  added  a  pen- 
alty of  5  per  cent  of  the  amount  of  the  tax,  and  inter- 
est at  the  rate  of  1  per  cent  a  month  until  it  is  paid. 
If  a  claim  for  abatement  is  made  the  5  per  cent  penalty 
is  stayed  until  the  claim  is  rejected. 

More  than  one  of  these  penalties  may  be  incurred  in 
connection  with  the  same  return.  If  all  the  facts  caus- 
ing the  different  penalties  are  known  all  the  penalties 


24  INCOME   AND    FEDERAL    TAX   REPORTS 

will  be  assessed  at  the  same  time,  but  the  assessing  of 
only  one  penalty  is  no  bar  to  the  assessing  of  another 
penalty  for  the  same  return  at  a  future  date. 

Checking  up  taxpayers. — Section  3172  of  the  Revised 
Statutes  provides  that  "every  collector  shall,  from  time 
to  time,  cause  his  deputies  to  proceed  through  every 
port  of  his  district  and  inquire  after  and  concerning  all 
persons  who  are  liable  to  pay  any  internal  revenue  tax, 
and  all  persons  owning  or  having  the  care  and  man- 
agement of  any  objects  liable  to  pay  any  tax,  and  to 
make  a  list  of  such  persons  and  enumerate  said  ob- 
jects." 

Various  methods  are  used  by  the  collectors  in  com- 
pliance with  this  provision  of  the  law  as  it  is  applied 
to  the  Inheritance  Income  Tax.  Under  the  1916  law, 
with  exemptions  of  $3,000  and  $4,000,  the  local  collec- 
tors would  make  up  lists  of  all  purchasers  of  auto- 
mobiles, etc.,  of  all  persons  occupying  apartments  rent- 
ing for  over  $1,000  a  year,  and  other  similar  lists  of 
people  who  would  seem  to  be  having  an  income  of 
$3,000. 

With  the  exemption  reduced  to  $1,000  and  $2,000, 
the  work  of  the  collectors  will  be  more  difficult.  The 
new  provision,  however,  regarding  information  at  the 
source,  will  undoubtedly  furnish  a  check  on  almost 
every  person  liable  to  the  tax. 

When  a  collector  has  information  indicating  that  any 
person  in  his  district  has  neglected  to  file  a  return  he 
may  send  out  the  following  form  letter: 

Sir: 

This  office  is  in  possession  of  information  which  indicates  that  for  the 
taxable  period  January  1  to  December  31,  1917,  you  were  in  receipt  of  aa 
income  subject  to  the  income  tax. 

The  records  of  this  office  do  not  show  that  you  have  made  and  filed  a 
return  of  income  for  this  taxable  period. 

Under  the  authority  of  section  3173,  Revised  Statutes  of  the  United 
States,  as  amended  and  made  part  of  the  Income  Tax  Law,  you  are  re- 
quested and  required  to  make  and  file,  within  ten  days  after  the  date  of 
this  letter,  a  return  of  your  income  for  the  period  January  1,  1917,  to  De- 


ADMINISTRATION  25 

cember  31,  1917,  inclusive,  in  accordance  with  Income  Tax  Form  1040,  two 
copies  of  which  are  herewith  enclosed. 

Should  you  fail  to  make  and  file  a  return  of  income  within  the  time 
herein  limited  it  is  made  the  duty  of  the  Collector  "to  summon  such  per- 
son, or  any  other  person  having  possession,  custody  or  care  of  books  of 
account  relating  to  the  business  of  such  person,  or  any  other  person  he 
may  deem  proper,  to  appear  before  him  and  produce  such  books,  at  a  time 
and  place  named  in  the  summons,  and  to  give  testimony  or  answer  inter- 
rogatories, under  oath,  respecting  any  objects  liable  to  tax  or  the  returns 
thereof." 

Paragraph  K  of  the  Income  Tax  Law  confers  jurisdiction  upon  the  dis- 
trict courts  of  the  United  States  for  the  district  within  which  any  person 
summoned  under  this  section  to  appear  to  testify  or  to  produce  books  shall 
reside,  to  compel  attendance,  production  of  books,  and  testimony  by  appro- 
priate process. 

Respectfully, 


(Signature) 

Collector. 


Right  of  collector  to  make  returns. — Where  no  return 
is  filed  or  where  the  return  is  false  or  fraudulent  the 
collector  has  the  right  to  examine  the  books  and  rec- 
ords of  the  individual  or  corporation  and  make  up  a 
return  from  such  information  as  he  can  secure.  Such 
a  return  is  held  prima  facie  good  for  the  purpose  of 
assessment  and  for  all  legal  purposes. 

The  United  States  District  Courts  are  given  juris- 
diction on  any  suits  arising  under  the  Income  Tax  Law, 
and  have  the  power  to  compel  the  attendance  of  wit- 
nesses and  the  production  of  books  and  testimony. 

Second  notice  of  tax  assessment. — In  the  event  of  fail- 
ure to  pay  the  tax  on  or  before  due  date  a  second  no- 
tice is  sent  to  the  taxpayer  immediately  following  the 
due  date.  This  notice,  which  is  very  similar  to  the  first 
notice,  reads  as  follows: 

Having  failed  to  make  payment  of  taxes  set  forth  opposite,  within  the 
prescribed  time  of  notice  and  demand  on  Form  17,  there  has  attached  a  5 
per  cent  penalty  on  said  tax  and  interest  at  1  per  cent  per  month  from 
date  given  below,  demand  is  made  for  said  taxes,  penalty,  and  such  inter- 
est as  may  accrue  before  payment.  If  payment  is  not  made  within  10  days 
from  the  above  date,  it  will  be  my  duty  to  collect  the  same  with  costs  by 
seizure  and  sale  of  property. 

Date  interest  began 


Collector  of  Internal  Revenue. 


26  INCOME   AND   FEDERAL    TAX    REPORTS 

Receipts  for  payment  of  taxes. — In  the  case  of  stamp 
taxes,  the  placing  of  the  stamp  on  the  document  or 
commodity  taxed  is  sufficient  evidence  of  payment. 

On  all  other  taxes  the  collector  is  required  to  give  an 
official  receipt.  This  official  receipt  is  the  only  receipt 
that  will  be  accepted  by  the  Department  as  evidence  of 
the  payment  of  the  tax. 

Deputy  collectors  may  sign  personal  receipts  or 
voucher  receipts,  but  these  are  merely  for  the  con- 
venience of  the  taxpayer,  and  are  not  official  receipts. 

Auditing  and  investigation  of  return. — After  the  re- 
turns are  checked  against  the  assessment  lists  at  Wash- 
ington they  are  turned  over  to  the  Chief  Revenue  Offi- 
cer for  auditing.  The  returns  are  checked  first  for 
mathematical  accuracy,  second  for  compliance  with  the 
law,  and  third  for  evidence  of  fraud.  Any  mathe- 
matical errors  on  the  return  are  corrected,  and  if  nec- 
essary an  additional  assessment  is  made. 

Where  the  return  does  not  give  all  the  required  in- 
formation or  where  there  is  evidence  of  fraud  an  ab- 
stract of  the  return  is  made  and  turned  over  to  the 
supervisor  of  the  field  force  of  the  district  in  which 
the  return  was  filed,  for  investigation.  This  field  force 
of  investigators  now  numbers  about  1,100  men,  but  it 
is  being  rapidly  increased,  and  by  the  middle  of  1918 
will  no  doubt  number  about  2,500  men. 

It  is  impossible  to  say  just  what  items  will  cause  an 
investigation  of  a  return.  As  a  general  rule,  the  most 
frequently  investigated  items  are  expenses,  losses,  bad 
debts  and  depreciation.  The  examining  officer  has  the 
right  to  examine  the  books  and  records  of  the  person 
or  corporation  making  the  report  to  determine  their  ac- 
curacy. On  the  basis  of  his  investigation  he  either 
reports  the  original  return  correct  or  makes  recom- 
mendation for  assessment  of  additional  tax,  as  dis- 
closed to  be  due.  The  salaries  of  these  inspectors  are 
in  no  way  dependent  upon  the  amount  of  additional  tax 


ADMINISTRATION  27 

assessed  as  a  result  of  their  investigations.  The  results 
show  that  there  are  very  few  cases  of  intentional  fraud, 
and  that  most  incorrect  returns  are  due  to  a  misun- 
derstanding of  the  requirements  of  the  Treasury  De- 
partment. 

"Where  a  revised  return  or  assessment  of  tax  is  made 
because  the  former  one  is  held  to  be  false  or  fraudu- 
lent the  taxpayer  cannot  question  the  new  assessment 
unless  he  proves  that  the  original  return  was  correct. 
This  provision  also  applies  in  cases  of  additional  assess- 
ments made  as  a  result  of  examinations  of  the  taxpay- 
ers' books  of  account  which  disclose  additional  tax  due. 

Claims  for  refund  and  abatement  of  taxes. — All  taxes 
erroneously  or  illegally  assessed  or  collected,  all  pen- 
alties collected  without  authority,  and  all  taxes  that 
appear  to  be  unjustly  assessed  or  excessive  in  amount, 
or  in  any  manner  wrongfully  collected,  will  be  re- 
funded to  the  taxpayer  if  they  have  already  been  paid, 
or  abated,  if  payment  has  not  been  made. 

Claims  for  the  refunding  of  assessed  taxes  and  pen- 
alties must  be  made  out  upon  Form  46,  prescribed  for 
that  purpose.  The  burden  of  proof  rests  upon  the 
claimant.  All  the  facts  relied  upon  in  support  of  the 
claim  should  be  clearly  set  forth  under  oath.  The 
claim  should  be  still  further  supported  by  the  attach- 
ment thereto  of  the  receipt  or  stamp  issued  in  the  pay- 
ment of  the  tax.  Claims  can  now  be  made  for  refund 
of  taxes  paid  under  the  act  of  August  5,  1909,  act  of 
October  3,  1913,  and  act  of  September  8,  1916,  if  the 
question  involves  a  review  of  the  return,  notwithstand- 
ing the  two-years'  "Statute  of  Limitations"  under  the 
provisions  of  section  3228  of  the  Revised  Statutes  of 
the  United  States.  Such  claims  should  be  filed  with 
the  collector  of  internal  revenue  in  the  district  wherein 
the  tax  was  paid  for  which  claim  for  refund  is  made. 

A  claim  for  abatement  of  tax  must  be  filed  on  Form 
47.     The  claim  must  be  sustained  by  the  affidavits  of 


28  INCOME   AND    FEDERAL    TAX    REPORTS 

the  party  against  whom  the  tax  was  assessed  or  of 
other  parties  cognizant  of  the  facts,  and  must  be  ac- 
companied by  the  affidavit  of  the  deputy  collector  and 
the  collector  of  the  division  in  which  the  claim  arose. 

Suit  to  restrain  assessment  or  collection  of  taxes. — Sec- 
tion 3224  of  the  Bevised  Statutes  provides  that  "no 
suit  for  the  purpose  of  restraining  the  assessment  or 
collection  of  any  tax  shall  be  maintained  in  any  court." 

If  an  assessment  is  made  which  the  taxpayer  be- 
lieves is  excessive  he  may  file  a  claim  for  abatement. 
If  that  is  refused  he  must  pay  the  tax.  He  may  then 
enter  a  claim  for  a  refund,  and  if  that  is  refused  his 
only  recourse  is  the  courts. 

Suits  for  recovery  of  taxes  wrongfully  collected. — No 
suit  will  be  maintained  in  any  court  for  the  recovery  of 
taxes  wrongfully  collected  unless  an  appeal  has  been 
made  to  the  Commissioner  of  Internal  Eevenue  in  the 
manner  explained  above,  and  a  decision  obtained.  If, 
however,  the  decision  is  delayed  more  than  six  months 
from  the  date  of  the  appeal  suit  may  be  brought  with- 
out awaiting  the  decision  of  the  Commissioner. 

Compromises. — The  Commissioner  of  Internal  Eev- 
enue is  permitted  to  compromise  any  civil  or  criminal 
case  arising  under  the  internal  revenue  laws  before 
commencing  suit  thereon,  and  also  after  the  instituting 
of  suit  by  the  Government. 

Secrecy  of  returns. — The  law  provides  that  "it  shall 
be  unlawful  for  any  collector,  deputy  collector,  agent, 
clerk  or  other  officer  or  employee  of  the  United  States 
to  divulge  or  to  make  known  in  any  manner  not  pro- 
vided by  law  to  any  person  the  operations,  style  of 
work,  or  apparatus  of  any  manufacturer  or  producer 
visited  by  him  in  the  discharge  of  his  official  duties,  or 
the  amount  or  source  of  income,  profits,  losses,  expen- 
ditures, or  any  particular  thereof,  set  forth  or  dis- 
closed in  any  income  return,  or  to  permit  any  income 
return  or  copy  thereof  or  any  book  containing  any  ab- 


ADMINISTRATION  29 

stract  or  particulars  thereof  to  be  seen  or  examined  by 
any  person  except  as  provided  by  law,  and  it  shall  be 
unlawful  for  any  person  to  print  or  publish  in  any  man- 
ner whatever  not  provided  by  law  any  income  return 
or  any  part  thereof  or  source  of  income  profits,  losses, 
or  expenditures  appearing  in  any  income  return.  An 
offense  against  the  provision  is  a  misdemeanor  and  is 
punishable  by  a  fine  not  exceeding  $1,000  or  by  impris- 
onment not  exceeding  one  year,  or  both,  at  the  discre- 
tion of  the  court,  and  if  the  offender  is  an  officer  or 
employee  of  the  United  States  he  will  be  dismissed 
from  office  or  discharged  from  employment. 

Use  of  returns  for  public  records. — The  following  rules 
and  regulations  for  the  inspection  of  returns  have  been 
made  by  the  Secretary  of  the  Treasury,  with  the  ap- 
proval of  the  President,  and  published  as  T.  D.  2016: 

1.  The  return  of  every  individual  and  of  every  corporation,  joint  stock 
company  or  association,  and'  every  insurance  company,  whether  foreign  or 
domestic,  shall  be  open  to  the  inspection  of  the  proper  officers  and  em- 
ployees of  the  Treasury  Department.  Returns  of  individuals  shall  not  be 
subject  to  inspection  by  any  one  except  the  proper  officers  and  employees  of 
the  Treasury  Department. 

2.  Where  access  to  any  return  of  any  corporation  is  desired  by  an  offi- 
cer or  employee  of  any  other  department  of  the  Government,  an  application 
for  permission  to  inspect  such  return,  setting  out  the  reasons  therefor,  shall 
be  made  in  writing,  signed  by  the  head  of  the  executive  department  in  which 
such  officer  or  employee  is  employed,  and  transmitted  to  the  Secretary  of 
the  Treasury.  If  the  return  of  a  corporation  is  desired  to  be  used  in  any 
legal  proceedings  other  than  those  to  which  the  United  States  is  a  party, 
or  to  be  used  in  any  manner  by  which  any  information  contained  in  the  re- 
turn could  be  made  public,  the  application  for  permission  to  inspect  such 
return  or  to  furnish  a  certified  copy  thereof  shall  be  referred  to  the  Sec- 
retary of  the  Treasury. 

3.  All  returns,  whether  of  persons  or  of  corporations,  joint  stock  com- 
panies or  associations,  or  insurance  companies,  may  be  furnished,  upon 
approval  of  the  Secretary  of  the  Treasury,  for  use,  either  in  the  original 
or  by  certified  copies  thereof,  in  any  legal  proceedings  before  any  United 
States  grand  jury  or  in  the  trial  of  any  cause  to  which  both  the  United 
States  and  the  person  or  corporation  or  association  rendering  the  return 
are  parties  either  as  plaintiff  or  defendant,  and  in  the  prosecution  or  de- 
fense or  trial  of  which  action,  or  proceeding  before  a  grand  jury,  such  re- 
turn would  constitute  material  evidence,  but  in  any  case  arising  in  the  col- 
lection of  the  income  tax,  the  Commissioner  of  Internal  Revenue  may  fur- 


30  INCOME   AND    FEDERAL    TAX    REPORTS 

nish  for  use  to  the  proper  officer  either  the  original  or  certified  copies  of 
returns  without  the  approval  of  the  Secretary  of  the  Treasury.  In  all 
cases  where  the  use  of  the  original  return  is  necessary,  it  shall  be  placed  in 
evidence  by  the  Commissioner  of  Internal  Revenue  or  by  some  officer  of  the 
Bureau  of  Internal  Revenue  designated  by  him  for  that  purpose,  and  after 
such  original  return  has  been  placed  in  evidence  it  shall  be  returned  to  the 
files  in  the  office  of  the  Commissioner  of  Internal  Revenue  at  Washington, 
D.  C. 

4.  The  Secretary  of  the  Treasury,  at  his  discretion,  upon  application  to 
him  made,  setting  forth  what  constitutes  a  proper  showing  of  cause,  may 
permit  inspection  of  the  return,  of  any  corporation,  by  any  bona-fide  stock- 
holder in  such  corporation.  The  person  desiring  to  inspect  such  return 
shall  make  application,  in  writing,  to  the  Secretary  of  the  Treasury,  set- 
ting forth  the  reasons  why  he  should  be  permitted  to  make  such  inspection, 
and  shall  attach  to  his  application  a  certificate  signed  by  the  president,  or 
other  principal  officer,  of  such  corporation,  countersigned  by  the  secre- 
tary, under  the  corporate  seal  of  the  company,  that  he  is  a  bona-fide  stock- 
holder in  said  company.  (Where  this  certificate  cannot  be  secured,  other 
evidence  will  be  considered  by  the  Secretary  of  the  Treasury  to  determine 
the  fact  whether  or  not  the  applicant  is  a  bona-fide  stockholder  and,  there- 
fore, entitled  to  inspect  the  return  made  by  such  company.)  Upon  re- 
ceipt of  such  application  the  corporation  whose  return  it  is  desired  to 
inspect  shall  be  notified  of  the  facts  and  shall  be  given  opportunity  to 
state  whether  any  legitimate  reason  exists  for  refusing  permission  to  make 
such  inspection.  The  privilege  of  inspecting  the  return  of  any  corporation 
is  personal  to  the  stockholders,  and  the  permission  granted  by  the  Secre- 
tary to  a  stockholder  to  make  such  inspection  cannot  be  delegated  to  any 
other  person. 

5.  The  returns  of  the  following  corporations  shall  be  open  to  the  inspec- 
tion of  any  person  upon  written  application  to  the  Secretary  of  the  Treas- 
ury, which  application  shall  set  forth  briefly  and  succinctly  all  facts  nec- 
essary to  enable  the  Secretary  to  act  upon  the  request: 

(a)  The  returns  of  all  companies  whose  stock  is  listed  upon  any 
duly  organized  and  recognized  stock  exchange  within  the  United  States, 
for  the  purpose  of  having  its  shares  dealt  in  by  the  public  generally. 

(b)  All  corporations  whose  stock  is  advertised  in  the  press  or  of- 
fered to  the  public  by  the  corporation  itself  for  sale.  In  case  of  doubt 
as  to  whether  any  company  falls  within  the  classification  above,  the 
person  desiring  to  see  such  return  should  make  application,  supported 
by  advertisements,  prospectus,  or  such  other  evidence  as  he  may  deem 
proper  to  establish  the  fact  that  the  stock  of  such  corporation  is 
offered  for  general  public  sale. 

Returns  can  be  inspected  only  in  the  office  of  the  Commissioner  of 
Internal  Revenue,  in  Washington,  D.  C.  In  no  case  shall  any  collec- 
tor, or  any  other  Internal  Revenue  officer  outside  of  the  Treasury 
Department  in  Washington,  permit  to  be  inspected  any  returns  or  fur- 
nish any  information  whatsoever  relative  to  any  return  or  any 
information  secured  by  him  in  his  official  capacity  relating  to  such 


ADMINISTRATION  31 

return,  except  in  answer  to  a  proper  subpoena,  in  a  case  to  which  the 
United  States  is  a  party. 

6.  Returns  of  individuals  shall  not  be  open  to  the  inspection  of  any  per- 
son other  than  the  proper  officers  and  employees  of  the  Treasury  Depart- 
ment or  person  rendering  the  same,  and  are  under  no  conditions  to  be  made 
public,  except  where  such  publicity  shall  result  through  the  use  of  such 
returns  in  any  legal  proceedings  in  which  the  United  States  is  a  party. 

7.  Upon  request  of  the  governor  of  a  State  imposing  a  general  income 
tax,  the  proper  officer  of  such  State,  to  be  designated  by  name  and  official 
position  by  the  Governor  of  such  State,  in  his  application  to  the  Secretary 
of  the  Treasury,  may  have  access  to  the  returns  or  to  abstracts  thereof 
showing  the  name  and  income  of  each  corporation,  joint  stock  company  or 
association,  or  insurance  company,  at  such  times  and  such  manner  as  the 
Secretary  of  the  Treasury  may  prescribe.  Such  application  shall  be  in 
writing,  addressed  to  the  Secretary  of  the  Treasury,  and  shall  show  (first) 
that  the  State,  whose  governor  makes  the  request,  imposes  a  general  in- 
come tax;  (second)  the  name  and  address  of  each  corporation,  etc.,  to 
which  access  is  desired;  (third)  why  permission  to  inspect  the  returns  of 
the  corporations,  etc.,  named  in  the  request  is  desired;  and  (fourth)  what 
officer  or  officers  are  designated  to  make  the  desired  inspection,  giving  their 
names  and  official  designations.  Such  request  must  be  signed  by  the  gov- 
ernor of  the  State  and  sealed  with  the  seal  thereof,  and  shall  be  transmitted 
to  the  Secretary  of  the  Treasury  for  his  consideration  and  action  thereon. 

No  provision  is  made  in  the  law  for  furnishing  a  copy  of  any  return  to 
any  person  or  corporation,  and  no  copy  of  any  return  will  be  furnished  to 
any  other  than  the  person  or  corporation  making  the  return,  or  their  duly 
constituted  attorney,  except  as  hereinbefore  authorized. 

The  provisions  herein  contained  shall  be  effective  on  and  after  the  1st 
day  of  September,  1914. 

W.  G.  McAdoo, 
Secretary  of  the  Treasury. 
Approved : 

Woodbow  Wilson, 

The  White  House,  July  28,  1914. 

(T.  D.  2016.) 


CHAPTER  III 
INDIVIDUAL  INCOME  TAX 

Income  Tax  laws  now  in  effect. — In  February,  1913,  the 
Sixteenth  Amendment  to  the  Constitution  of  the  United 
States  became  effective.  This  amendment  gave  to  Con- 
gress the  power  "to  lay  and  collect  taxes  on  incomes, 
from  whatever  source  derived,  without  apportionment 
among  the  several  States."  In  October,  1913,  the  first 
income  tax  was  repealed  and  a  new  law  substituted. 
This  law  is  still  in  effect.  On  October  3,  1917,  Con- 
gress passed  the  so-called  War  Revenue  Law.  This 
act  amended  the  1916  law  in  a  number  of  important 
matters,  and  among  other  things  imposed  an  additional 
"War  Income  Tax."  Income  for  the  calendar  year  of 
1917  is  therefore  subject  to  the  combined  taxes  jmposed 
by  the  1916  and  the  1917  laws. 

The  exemptions  allowed  under  the  "War  Income"  Act 
are  considerably  lower  than  under  the  1916  law,  and  it 
is  estimated  by  the  Treasury  Department  that  7,000,000 
more  people  will  pay  the  income  tax  under  the  new  law 
than  paid  under  the  old  law. 

WHO   MUST  FILE  REPORTS 

Returns  required. — Under  the  law  as  it  is  in  effect  for 
the  year  1917  returns  *  of  net  income  will  be  re- 
quired of: 

i  The  word  "return"  frequently  is  used  in  discussion  of  the  income  tax. 
No  definition  is  given  since  the  word  has  come  to  have  a  fairly  well  defined 
meaning  in  connection  with  the  administration  of  tax  laws.  A  "return"'  is 
simply  the  sworn,  signed  statement  of  a  person,  which  is  to  be  filed  or 
"returned"  to  the  proper  tax  office  that  there  may  be  calculated  the  amount 
of  tax  that  the  person  making  the  return  will  be  obliged  to  pay. 

32 


INDIVIDUAL    INCOME    TAX  33 

1.  Every    individual,    a    citizen    or    resident    of    the 

United  States,  having  a  net  income  of: 

(a)  $1,000  or  over  if  unmarried,  or  married  but 

not  living  with  husband  or  wife.1 

(b)  $2,000  or  over  if  married  and  living  with  hus- 

band or  wife.2  If  the  husband  and  wife  have 
separate  incomes,  each  may  report  their  in- 
come separately,  or  they  may  report  their 
combined  income  on  one  return.  In  the  lat- 
ter event,  the  normal 3  tax  is  computed  upon 
the  joint  income,  but  the  super-tax  is  com- 
puted only  upon  the  separate  income  of 
each.  If  the  income  of  husband  and  wife  to- 
gether, or  of  husband,  wife  and  minor  chil- 
dren together,  or  of  parent  and  minor  chil- 
dren together  exceeds  $5,000,  a  separate  re- 
port should  be  filed  for  the  income  of  each. 
Otherwise,  it  is  possible  that  the  super-tax 
may  be  imposed  on  the  joint  income,  whereas, 
the  intention  of  the  law  is  that  the  super-taxes 
be  imposed  only  on  the  separate  incomes. 

2.  Every    non-resident    alien    having    a    net    income 

from  sources  within  the  United  States  regard- 
less of  the  amount  or  character  of  such  net  in- 
come.4 

i  In  so  far  as  the  exemption  from  filing  a  return  is  concerned  the  Treas- 
ury Department  treats  a  married  person  not  living  with  husband  or  wife 
as  if  unmarried.  The  fact  that  an  individual  is  treated  as  unmarried  for 
the  purpose  of  filing  a  return  does  not  prevent  such  individual  from  taking 
advantage  of  the  specific  exemption  of  $2,000.  There  will  undoubtedly  be 
a  number  of  cases  where  a  return  will  be  required  but  where  no  tax  will 
be  levied. 

*  No  return  of  net  income  will  be  required  of  husband  and  wife  living 
together  during  the  year  1917  and  subsequent  years  when  the  separate  in- 
come of  either  exceeds  $1,000  but  the  combined  income  does  not  equal  or 
exceed  $2,000. 

3  See  Chapter  on  Rate  of  Tax,  p.  126. 

*  From  the  rulings  of  the  Department  it  might  seem  that  no  returns 
will  be  required   of  non-resident  aliens   having   an  income   from  sources 


34  INCOME   AND   FEDERAL    TAX   REPORTS 

No  returns,  however,  are  required  of  foreign  gov- 
ernments receiving  income  from  investments  in 
the  United  States  in  stocks,  bonds  or  other  do- 
mestic securities  owned  by  such  foreign  govern- 
ments, or  from  interest  on  deposits  in  banks  in 
the  United  States  belonging  to  foreign  govern- 
ments. 

3.  Every  executor  or  administrator  for: 

(a)  The  net  income  of  a  decedent  from  January 

1  to  the  date  of  his  death,  provided  such  in- 
come was  $1,000  or  over  (or  $2,000  or  over 
in  case  the  decedent  was  married  and  living 
with  husband  or  wife  at  time  of  death). 

(b)  Net  income  received  by  the  estate  during  pe- 

riod of  administration  or  settlement,  the  in- 
come of  which  is  distributed  annually  to 
beneficiaries,  provided  the  amount  paid  to 
any  one  beneficiary  equals  $1,000  or  $2,000 
according  to  the  marital  status  of  the  bene- 
ficiary, and  where  more  than  one  beneficiary 
is  shown  on  the  return  the  lowest  exemption 
would  determine  the  liability  for  the  purpose 
of  making  a  return. 

(c)  Income  of  any  trust  estate  not  distributed,  pro- 

vided it  is   $1,000   or   over.     It   should   be 

within  the  United  States  of  less  than  $3,000.  This  mistake  is  caused  by 
the  fact  that  under  the  law  of  September  8,  1916,  non-resident  aliens  were 
not  required  to  file  a  return  unless  their  income  was  $3,000  or  over.  They 
were  also  allowed  the  specific  exemption  of  $3,000  or  $4,000.  By  the  amend- 
ments of  October  3,  1917,  the  right  to  the  specific  exemption  was  taken 
away  and  for  the  year  1917  non-resident  aliens  are  therefore  taxed  on  their 
entire  taxable  net  income.  It  is  true  that  the  normal  tax  of  2  per  cent, 
on  all  income  accruing  in  the  United  States  to  non-resident  aliens  is  to  be 
withheld  at  the  source,  but  there  are  any  number  of  circumstances  where 
this  withholding  is  impracticable.  To  protect  itself,  the  Treasury  Depart- 
ment will  require  returns  of  every  non-resident  alien  for  his  entire  taxable 
income  derived  from  all  sources  in  the  United  States,  corporate  or  other- 
wise, regardless  of  the  character  or  amount  of  such  income. 


'INDIVIDUAL   INCOME    TAX  35 

noted,  however,  that  no  exemption  is  allowed 
to  estates  of  non-resident  alien  decedents. 


4.  Fiduciaries  acting  for  minors  or  other  incom- 
petents, provided  the  net  income  is  $1,000  or 
$2,000,  according  to  their  marital  status. 

Definition  of  "every  individual." — "Every  individual" 
means  every  person  of  lawful  age,  regardless  of  sex. 
The  income  of  a  dependent  child  under  the  age  of  18 
should  be  included  with  that  of  the  head  of  the  family, 
who  is  allowed  an  additional  deduction  for  every  child 
so  dependent  (see  specific  exemption,  discussed  later), 
unless  such  income  was  derived  from  a  separate  estate 
under  control  of  a  guardian,  trustee  or  other  fiduciary. 
Income  of  a  minor  or  incompetent,  derived  from  a  sepa- 
rate estate,  must  be  reported  by  his  legal  represen- 
tative. 

The  status  of  an  individual  as  to  whether  such  in- 
dividual must  file  a  return  when  income  equals  $1,000 
but  is  not  in  excess  of  $2,000  is  determined  by  the 
status  as  of  the  end  of  the  year  for  which  the  return  is 
filed. 

It  must  be  borne  in  mind  that  the  exemption  from 
filing  a  return  is  not  on  the  same  basis  as  the  specific 
exemption  allowed  from  the  normal  tax.  To  illustrate: 
A,  who  is  supporting  a  crippled  brother,  has  an  income 
of  $1,500.  As  the  head  of  a  family  (defined  on  p.  130), 
he  is  allowed  a  specific  exemption  of  $2,000.  He  must, 
nevertheless,  file  a  return,  because  his  income  is  in 
excess  of  $1,000  and  he  does  not  come  within  the  clas- 
sification of  "married  and  living  with  husband  or  wife." 

Payment  of  income  taxes  to  foreign  countries  does  not 
exempt  from  tax. — Any  individual  subject  to  the  income 
tax  is  not  relieved  from  liability  to  the  tax  by  reason 
of  the  fact  that  such  individual  is  also  subject  to  the 
income  tax  laws  of  other  countries. 


36  INCOME   AND    FEDERAL    TAX   REPORTS 

Meaning  of  "State"  and  "United  States."— The  1916  In- 
come Tax  law  provides:  "That  the  word  "State"  or 
"United  States,"  when  used  in  this  title,  shall  be  con- 
strued to  include  any  territory,  the  District  of  Colum- 
bia, Porto  Eico,  and  the  Philippine  Islands,  when  such 
construction  is  necessary  to  carry  out  its  provisions." 

The  act  of  October  3,  1917,  states  distinctly  that  its 
provisions  do  not  extend  to  Porto  Rico  and  the  Philip- 
pine Islands. 

Residents  of  the  Philippine  Islands  and  Porto  Rico 
are  therefore  subject  to  the  tax  only  at  the  rates  im- 
posed by  the  1916  law. 

Citizenship. — Citizens  born  in  the  United  States,  even 
though  they  have  resided  abroad  for  a  number  of  years, 
will  for  taxing  purposes  be  considered  citizens  of  the 
United  States,  unless  they  have  definitely  renounced 
their  citizenship.  But  under  the  provisions  of  an  act 
dated  March  2,  1907  (sec.  2),  a  naturalized  citizen 
raises  the  presumption  of  expatriation  by  his  protracted 
residence  abroad.  The  Treasury  Department,  however, 
has  held  that  "an  individual's  native  or  naturalized 
status  remains  unless  changed  by  affirmative  action  or 
forfeited  by  an  overt  act."  Thus,  cases  may  arise  where 
an  individual  will  be  held  by  the  State  Department  to 
have  expatriated  himself  by  reason  of  his  protracted 
residence  abroad  and  at  the  same  time  will  be  held  by 
the  Treasury  Department  as  subject  to  the  income  tax 
as  a  citizen  of  the  United  States. 

It  will  be  noted  that  if  a  woman  marries  a  foreigner 
she  takes  the  nationality  of  her  husband. 

When  is  an  alien  "resident"  in  the  United  States. — 
"Residence"  is  held  to  be  "that  place  where  a  man  has 
his  true,  fixed  and  permanent  home  and  principal  es- 
tablishment and  to  which,  whenever  he  is  absent,  he  has 
the  intention  of  returning;  and  indicates  permanency 
of  occupation  as  distinct  from  lodging  or  boarding,  or 
temporary  occupation." 


INDIVIDUAL    INCOME    TAX  37 

Where,  for  business  purposes  or  otherwise,  an  alien 
is  permanently  located  in  the  United  States;  has  there 
his  principal  business  establishment  and  is  there  per- 
manently occupied  or  employed,  even  though  his  domi- 
cile may  be  without  the  United  States,  he  will  be  con- 
sidered a  resident  of  the  United  States. 

But  aliens  who  are  physically  present  in  the  United 
States,  and  only  temporarily  resident  or  employed 
therein  (as  for  a  season  or  other  similarly  definite  term, 
and  with  the  expectation  or  intention  of  leaving  the 
United  States  upon  the  termination  of  employment  or 
accomplishment  of  the  purpose  which  necessitated  their 
presence  in  the  United  States),  are  not  considered 
"residents"  of  the  United  States  for  income  tax  pur- 
poses. 

Practical  effect  of  distinction  between  "residents  and  citi- 
zens of  the  United  States"  and  "non-resident  aliens." — A 
person  who  is  considered  a  citizen  or  resident  of  the 
United  States  is  subject  to  the  income  tax  at  the  rates 
provided  in  both  the  September  8,  1916,  act  and  the 
October  3,  1917,  act,  and  must  report  all  income  from 
all  sources  within  or  without  the  United  States.  Such 
individuals,  however,  are  allowed  the  specific  exemp- 
tions of  $3,000  or  $4,000  as  provided  in  the  1916  law 
and  of  $1,000  or  $2,000  as  provided  in  the  1917  law. 

A  person  who  is  a  non-resident  alien  is  subject  to  the 
2  per  cent  normal  tax  of  the  1916  law,  but  not  to  the  2 
per  cent  normal  tax  imposed  by  the  1917  law,  but  he  is 
subject  to  the  super-tax  imposed  by  both  laws.  How- 
ever, he  need  report  only  such  income  as  arises  from 
sources  within  the  United  States.  Such  individuals  are 
not  entitled  to  any  personal  exemption.  That  is  to  say, 
they  are  taxed  on  their  entire  net  income  arising  from 
sources  within  the  United  States. 

What  is  net  income? — In  order  to  determine  whether 
or  not  an  income  tax  return  should  be  filed,  the  net  in- 
come must  first  be  ascertained,  by  deducting  from  the 


38  INCOME   AND   FEDERAL    TAX   REPORTS 

gross  income  (not  including  exempt  items,  which  need 
not  be  reported),  the  following  items,  subject  to  the 
regulations  of  the  Treasury  Department: 

1.  Business  expenses. 

2.  Interest  paid. 

3.  Taxes  paid. 

4.  Losses  incurred. 

5.  Bad  debts. 

6.  Depreciation. 

Summary  outline. — The  scheme  of  the  Individual  In- 
come Tax  law  and  of  its  administration  will  possibly 
be  clearer  to  the  reader  after  he  has  studied  carefully 
the  following  outline,  which  is  given  partly  by  way  of 
summary  of  what  has  already  been  said  and  partly  in 
anticipation  of  questions  yet  to  be  taken  up. 

Individuals : 

A.  Those  who  file  no  report. 

1.  Unmarried,   or  married  but  not   living   with 

spouse,    and   having    income    of    less    than 
$1,000. 

2.  Married   and   living  with   spouse   but   having 

joint  income  (of  individual  and  spouse)   of 
less  than  $2,000. 

B.  Those  who  file  a  report. 

1.  Unmarried,   or   married   but   not   living   with 

spouse    and    having    income    of    $1,000    or 
more. 

2.  Married   and  living  with   spouse   and   having 

joint  income  of  $2,000  or  more. 

3.  Non-resident  aliens,  regardless  of  amount  of 

income. 
Items  of  Income: 

A.  Exempt  items — those  which  should  not  be  re- 

reported. 

B.  Partially  exempt  items — those  which  must  be 

reported  but  which  may  be  subject  to  only  a 


INDIVIDUAL   INCOME    TAX  39 

part  or  parts  of  the  tax.  The  total  tax  pay- 
able for  the  year  1917  may  really  be  divided 
into  four  parts:  (1)  the  normal  tax  of  the 
1916  law;  (2)  the  super-tax  of  the  1916  law; 
(3)  the  normal  tax  of  the  1917  law;  (4)  the 
super-tax  of  the  1917  law. 
C.  Fully  taxable  items — those  items  which  are  to 
be  reported  and  are  subject  to  all  the  taxes. 

EXEMPT  INCOME— NOT  REPORTABLE 

Income  exempt  from  taxation  and  which  may  be  omitted 
from  the  income  tax  reports. — The  Income  Tax  law,  sec. 
4,  exempts  the  following  items  of  income: 

1.  (a)  The  proceeds  of  life  insurance  policies  paid  to 
individual  beneficiaries  upon  the  death  of  the  insured; 
(b)  the  amount  received  by  the  insured  as  a  return  of 
a  premium  or  of  premiums  paid  by  him  under  life  in- 
surance, endowment,  or  annuity  contracts,  either  dur- 
ing the  term  or  at  the  maturity  of  the  term  mentioned 
in  the  contract  or  upon  surrender  of  the  contract. 

2.  The  value  of  property  acquired  by  gift,  bequest, 
devise  or  descent.  But  the  income  from  such  property 
must  be  reported  as  income. 

3.  Interest  upon  the  obligation  of  a  State  or  any  po- 
litical subdivision  thereof  or  upon  the  obligations  of 
the  United  States  (but  in  the  case  of  obligations  of  the 
United  States  issued  after  September  1, 1917,  only  if  and 
to  the  extent  provided  in  the  act  authorizing  the  issue 
thereof)  or  its  possessions,  or  securities  issued  under 
the  provisions  of  the  Federal  Farm  Loan  act  of  July 
17,  1916. 

4.  The  compensation  of  the  present  President  of  the 
United  States  during  the  term  for  which  he  has  been 
elected. 

5.  The  compensation  of  the  judges  of  the  Supreme 
and  inferior  courts  of  the  United  States  in  office  as  of 
October  3,  1917. 


40  INCOME   AND   FEDERAL    TAX   REPORTS 

6.  The  compensation  of  all  officers  and  employees  of 
a  State,  or  any  political  subdivision  thereof,  except 
when  such  compensation  is  paid  by  the  United  States 
Government. 

Proceeds  of  life  insurance  policies. — When  the  proceeds 
of  insurance  policies  are  paid  to  a  beneficiary  other 
than  the  insured  these  proceeds  are  entirely  exempt. 
But  where  the  amount  returned  on  a  life  insurance, 
endowment  or  annuity  contract  is  paid  to  the  person 
making  the  contract,  either  upon  the  maturity  or  sur- 
render of  the  contract,  the  amount  by  which  the  sum 
received  exceeds  the  sum  paid  is  (according  to  the 
ruling  of  the  Treasury  Department)  income,  and 
should  be  reported  as  such.  To  illustrate:  A  takes  out 
a  twenty-year  endowment  policy,  the  premium  of  which 
is  $40  a  year,  payable  to  his  wife  upon  his  death  if  it 
should  occur  prior  to  the  termination  of  the  twenty- 
year  period.  He  received  dividends  on  his  policy  aver- 
aging about  $2  a  year.  Should  he  die  before  the  ex- 
piration of  the  twenty-year  period,  his  wife  is  not  re- 
quired to  include  the  amount  received  ($1,000)  as  in- 
come. If  he  lives  to  collect  the  $1,000  he  must  return 
as  income  the  difference  between  the  amount  received, 
$1,000,  and  the  amount  paid  in,  [20  X  $38  ($40  — $2)], 
$760,  or  $240. 

Annuities. — Where  annuities  are  purchased  by  the  an- 
nuitant for  a  lump  sum  the  same  rule  holds.  So  much 
of  the  annuities  paid  to  the  annuitant  as  represents 
payments  made  by  him  on  an  annuity  contract  and  re- 
turned to  him  is  not  to  be  included  as  income  of  the 
annuitant.  Any  increment  on  the  purchase  price  of  an 
annuity  is  taxable  income.  To  illustrate :  An  annuity  of 
$3,500  is  purchased  for  the  lump  sum  of  $45,000.  The 
annuitant  would  not  have  to  include  the  annuity  in  his 
income  for  the  first  twelve  years  of  the  contract,  at  the 
end  of  which  time  he  would  have  collected  $42,000. 
In  the  thirteenth  year  he  would  report  as  income  $500 


INDIVIDUAL    INCOME    TAX  41 

— the  difference  between  the  total  amount  received  by 
him  up  to  that  time  ($45,500)  and  the  original  amount 
which  the  annuity  had  cost  him  ($45,000).  Thereafter 
he  would  include  the  entire  annual  payment  of  $3,500 
as  income. 

Dividends  from  life  insurance  policies. — Dividends  paid 
on  life  insurance  policies  that  have  not  matured, 
whether  such  dividends  are  drawn  in  cash  by  the  in- 
sured or  applied  to  the  reduction  of  the  premium  due, 
are  not  considered  items  of  taxable  income  under  the 
law,  and  should  be  excluded  from  a  return  of  income. 

Dividends  from  paid-up  policies,  however,  are  consid- 
ered income  to  the  recipient,  and  must  be  included  in 
the  annual  return  of  income  as  such. 

Value  of  property  acquired  by  gift,  bequest,  devise  or 
descent  is  exempt. — While  the  value  of  property  ac- 
quired by  gift  is  not  subject  to  the  income  tax,  all 
gains,  profits,  or  income  derived  therefrom  are  subject 
to  the  tax,  and  if  the  property  so  acquired  is  subse- 
quently sold  at  a  price  greater  than  the  appraised 
value  at  the  time  the  property  was  acquired  by  gift,  if 
acquired  subsequent  to  March  1,  1913,  the  gain  in  value 
is  held  to  be  income  and  is  subject  to  the  tax.  If  the 
property  was  acquired  by  gift  prior  to  March  1,  1913, 
and  sold  thereafter,  the  gain,  if  any,  is  the  difference 
between  the  market  value  March  1,  1913,  and  the  sell- 
ing price.  Any  increment  in  the  value  of  the  property 
prior  to  March  1,  1913,  need  not  be  reported  and  is 
exempt  from  tax. 

Meaning  of  "Political  subdivision  of  a  State." — The  law 
exempts  from  the  tax  interest  on  obligations  of  a  State 
or  any  political  subdivision  thereof.  The  term  "po- 
litical subdivision"  includes  special  assessment  districts 
or  divisions  of  a  State  created  by  the  proper  authority 
of  the  State  acting  within  its  constitutional  powers  and 
under  its  general  laws,  for  the  purpose  of  carrying  out 
a  portion  of  those  functions  of  the  State  which  by  long 


42  INCOME   AND   FEDERAL    TAX   REPORTS 

usage  and  inherent  necessities  of  government  have  al- 
ways been  regarded  as  public.  This  definition  is  very 
broad  and  includes  cities,  towns,  villages,  school  dis- 
tricts, road  districts,  levee  districts  and  other  special 
assessment  districts  created  under  the  laws'of  the  State 
for  public  purposes,  such  as  the  improvement  of  streets 
and  highways,  the  provision  of  sewerage,  gas  and  light, 
and  the  reclamation,  drainage  or  irrigation  of  bodies  of 
land  within  such  special  assessment  districts,  provided 
such  districts  are  for  public  use. 

But  where  a  municipality  purchases  a  public  utility 
subject  to  a  mortgage,  the  mortgage  retains  its  original 
character,  even  though  the  municipality  assumes  the 
mortgage  and  pays  the  interest  thereon.  The  indebt- 
edness secured  by  such  a  mortgage  is  not  an  obliga- 
tion of  a  "political  subdivision"  of  a  State,  and  the  in- 
terest therefrom  is  not  exempt  from  tax. 

Exemption  of  income  on  bonds  of  the  United  States. — 
Interest  upon  the  obligations  of  the  United  States  or 
its  possessions  issued  prior  to  September  1,  1917,  is 
entirely  exempt  from  the  tax,  and  need  not  be  included 
in  the  return  of  income. 

Interest  on  any  obligations  issued  subsequent  to  that 
date  is  exempt  only  if  such  exemption  is  provided  for 
in  the  law  authorizing  their  issue,  and  then  only  to  the 
extent  authorized. 

Interest  on  bonds  of  the  second  Liberty  Loan,  on 
Treasury  Certificates  of  Indebtedness  and  on  the  new 
War  Savings  Certificates  issued  under  the  act  of  Sep- 
tember 24,  1917,  should  be  included  in  the  return  to  the 
extent  that  such  interest  is  on  a  principal  amount  of  such 
securities  in  excess  of  $5,000.  This  is  because  the  inter- 
est is  exempt  only  from  the  normal  tax,  and  from  the 
super-tax  to  the  extent  of  the  interest  on  $5,000  par 
value  of  the  bonds  or  certificates. 

Interest  on  the  first  Liberty  Loan  bonds,  i.e.,  the  Sy2s, 
is  exempt  and  need  not  be  reported. 


INDIVIDUAL   INCOME    TAX  43 

Compensation  of  judges  of  U.  S.  Supreme  Court  and  in- 
ferior courts  exempt. — The  exemption  of  the  compensa- 
tion of  the  judges  of  the  Supreme  and  other  courts  of 
the  United  States  (i.e.,  Federal  Courts),  applies  only  to 
those  in  office  prior  to  October  4,  1917.  The  salary  of 
all  judges  appointed  subsequent  to  that  date  is  subject 
to  income  tax. 

Exemption  of  State  officers  and  employees. — The  com- 
pensation of  all  employees  of  a  State  or  of  any  po- 
litical subdivision  thereof  (for  definition  of  political 
subdivision  see  p.  41,  ante),  are  exempt.  But  when  State 
employees  are  compensated  by  the  United  States,  such 
income  is  taxable. 

It  must  be  borne  in  mind  that  an  individual  who 
enters  into  a  contract  with  a  State,  or  any  political 
subdivision  thereof,  for  the  construction  of  a  public 
highway  or  other  public  works,  is  held  not  to  be  an 
officer  or  employee  of  the  State  or  political  subdivision 
thereof.  Therefore,  the  amounts  received  by  him  from 
the  State  or  political  subdivision  thereof,  under  the 
terms  of  the  contract,  are  not  exempt  from  tax  under 
the  provisions  of  the  Federal  Income  Tax  law,  and 
should  be  included  in  any  return  of  annual  net  income 
which  the  contractor  may  be  required  to  render.  Of 
course,  it  follows  that  employees  of  such  a  contractor 
are  not  employees  of  a  State  or  of  any  political  sub- 
division thereof.  They,  too,  must  include  the  compen- 
sation received  from  the  contractor  in  any  return  re- 
quired. 

Salaries  of  government  officials  of  Porto  Rico,  the  Philip- 
pine Islands  and  the  District  of  Columbia. — Income  of  offi- 
cials of  Porto  Rico,  the  Philippine  Islands  and  the  Dis- 
trict of  Columbia  or  any  political  subdivision  thereof 
is  not  exempt  from  the  tax,  and  must  be  included  in 
the  return  filed. 


44         INCOME   AND   FEDERAL    TAX   REPORTS 
INCOME  TO  BE  REPORTED 

Gross  income. — The  gross  income  of  an  individual  in- 
cludes all  gains,  profits  and  income  derived  from  sala- 
ries, wages,  or  compensation  for  personal  service  of 
whatever  kind  and  in  whatever  form  paid;  or  from 
professional  vocations,  business,  trade,  commerce,  or 
sales;  or  from  dealings  in  property,  whether  real  or 
personal,  growing  out  of  the  ownership  or  use  of  or 
interest  in  real  or  personal  property;  also  from  inter- 
est, rent,  dividends,  securities,  or  the  transaction  of  any 
business  caried  on  for  gain  or  profit,  or  gains  or  profits 
and  income  derived  from  any  source  whatever. 

Non-resident  aliens. — But  the  non-resident  alien  need 
report  only  such  income  as  arises  from  sources  within 
the  United  States.  The  phrase  "from  sources  within 
the  United  States"  is  very  broad.  It  includes  income 
from  sales  of  goods  to  residents  within  the  United 
States,  royalties  received  on  patents  used  in  manufac- 
turing goods  in  the  United  States,  and  interest  on  bonds 
and  dividends  on  stock  of  domestic  corporations  owned 
by  non-resident  aliens,  even  though  the  securities  them- 
selves are  physically  located  and  payable  outside  of  the 
United  States.1 

The  fact  that  income  is  paid  in  the  United  States 
does  not  necessarily  mean  that  the  source  of  the  income 
is  in  the  United  States.  Interest  on  bonds  and  divi- 
dends on  the  stock  of  a  foreign  corporation,  for  exam- 
ple, even  though  paid  in  the  United  States,  is  not  in- 
come from  sources  within  the  United  States,  and  should 
not  be  included  in  the  report  filed  by  the  non-resident 
alien. 

Income  earned  prior  to  March  1,  1913,  not  taxable. — The 
intention  of  the  Income  Tax  law  is  to  tax  all  income 
earned  by  individuals  subsequent  to  March  1,  1913. 
The  general  practice  is  to  tax  the  income  received  in 

i  See  also  pp.  171,  172. 


INDIVIDUAL   INCOME    TAX  45 

any  year,  at  the  rates  in  effect  at  the  time  the  income 
is  reported.  Partnership  profits,  however,  are  required 
to  be  reported  when  earned,  regardless  of  whether 
they  are  distributed  or  not.  (See  Partnership  Income, 
page  71  post.)  Where  the  income  received  is  partly 
earned  prior  to  March  1,  1913,  and  not  received  by  the 
person  making  the  return  until  the  year  1917,  the  bur- 
den of  showing  what  part  of  the  income  was  actually 
earned  prior  to  March  1,  1913,  is  upon  the  taxpayer. 

Income  earned  in  previous  years. — Where  the  income 
which  is  reported  in  the  year  received  was  earned  in 
a  previous  year  or  years,  the  question  arises  as  to 
whether  the  income  should  be  taxed  at  the  rates  in 
effect  for  the  year  in  which  it  was  earned  or  those  in 
effect  for  the  year  in  which  it  was  reported.  The  an- 
swer is,  that  in  such  a  case  the  individual  must  pay  the 
tax  at  the  rate  in  effect  at  the  time  the  income  is  re- 
ported. The  taxpayer,  to  be  sure,  has  the  privilege  of 
reporting  his  income  when  earned,  instead  of  when  re- 
ceived, but  the  Department  correctly  holds  that  if  he 
does  not  take  advantage  of  this  privilege  he  must  pay 
the  tax  at  the  rates  in  effect  at  the  time  when  the  in- 
come is  received  and  reported. 

Dividends  received  from  corporations  are  an  excep- 
tion to  this  rule.  The  taxpayer  does  not  have  any 
option  as  to  the  time  of  reporting  such  income.  The 
income  is  not  earned  by  him  until  received,  though,  as 
a  matter  of  fact,  the  income  represented  by  the  divi- 
dends may  have  been  earned  by  the  corporation  in  a 
previous  year.  The  Department,  therefore,  holds  that 
dividends  are  taxable  at  the  rates  in  effect  in  the  year 
in  which  they  were  earned  by  the  corporation.  The 
burden  of  showing  that  the  dividends  were  earned  in 
years  previous  to  that  in  which  they  were  paid  is,  of 
course,  upon  the  taxpayer,  and  it  follows,  therefore, 
that  if  the  individual  does  not  prove  that  the  dividends 
were  earned  in  previous  years,  they  will  be  taxed  at 


46  "  INCOME   AND  FEDERAL    TAX    REPORTS 

the  rates  in  effect  in  the  year  in  which  they  are  re- 
ported.1 

In  the  case  where  an  individual  has  been  employed 
for  the  past  three  years  at  an  annual  salary  of  $5,000, 
but  due  to  the  financial  condition  of  the  employer  he 
has  received  only  $2,000  each  year,  and  in  1917  he  re- 
ceives all  his  back  salary,  plus  the  regular  salary 
of  $5,000,  the  total  amount  received  in  1917  salary 
must  be  then  included  as  income,  unless  it  had  been 
reported  in  previous  years  on  an  accrual  basis. 

Income  may  be  reported  either  when  received  or  when 
earned. — Section  1  of  the  Income  Tax  law  of  September 
8,  1916,  as  amended,  provides  that  the  tax  shall  be  lev- 
ied, assessed,  collected,  and  paid  annually  "upon  the 
entire  net  income  received  in  the  preceding  calendar 
year  from  all  sources."  However,  section  8,  paragraph 
(g),  further  provides  that,  "any  individual  keeping  ac- 
counts upon  any  basis  other  than  that  of  actual  receipts 
and  disbursements,  unless  such  other  basis  does  not 
clearly  reflect  his  income,  may,  subject  to  regulations 
made  by  the  Commissioner  of  Internal  Eevenue,  and 
with  the  approval  of  the  Secretary  of  the  Treasury, 
make  his  return  upon  the  basis  upon  which  his  accounts 
are  kept,  in  which  case  the  tax  shall  be  computed  upon 
his  income  as  so  returned." 

Thus,  if  an  amount  of  salary  earned  during  the  year 
was  not  received  until  some  date  subsequent  to  De- 
cember 31st  of  that  year,  it  need  not  be  reported  for 
the  year  in  which  it  was  earned,  unless  the  individual 
has  kept  his  accounts  on  an  accrual  basis  in  which  he 
credited  himself  with  that  salary  during  the  year  in 
which  it  was  earned.  If  the  accrual  basis  of  determin- 
ing income  is  used  one  year,  it  must  also  be  used 
the  following  year.  For  example:  A  is  employed  at  a 
salary  of  $500  a  month,  payable  on  the  15th  of  each 
month.     His  salary  is  raised  to  $750  a  month  begin- 

i  See  Dividends,  p.  78. 


INDIVIDUAL    INCOME    TAX  47 

ning  the  15th  of  June,  1917.  If  he  reported  his  1916 
income  on  the  basis  of  cash  received  he  will  report  for 
1917  an  income  from  salaries  of  $7,500.  But  if  he  re- 
ports his  1916  income  on  an  accrual  basis  he  will  re- 
port for  1917  an  income  from  salaries  of  $7,625. 

Classification  of  gross  income. — Gross  income  may  be 
classified  as  arising  from  the  following  sources  (each 
item  is  explained  in  full  in  the  following  pages) : 

1.  Salaries,  wages  and  commissions. 

2.  Income  from  professions  and  vocations. 

3.  Profits  from  business,  trade,  and  farm. 

4.  Profits  from  sales  or  dealings  in  property,  whether 
real  or  personal. 

5.  Royalties  from  mines,  oil  wells,  patents,  franchises 
or  other  legalized  privileges. 

6.  Rents. 

7.  Interest  on  notes,  mortgages,  bank  deposits,  other 
than  included  in  class  8  or  9,  below. 

8.  Interest  on  bonds,  mortgages,  or  deeds  of  trust,  or 
other  similar  obligations  of  domestic  corporations,  joint- 
stock  companies  or  associations,  and  insurance  com- 
panies. 

9.  Income  of  fiduciaries  in  their  trust  capacity  (ex- 
cept dividends  from  domestic  corporations  and  interest 
on  second  Liberty  Bonds). 

10.  Partnership  gains  or  profits  (excluding  dividends 
and  interest  on  second  Liberty  Bonds). 

11.  Interest  and  dividends  upon  securities  of  foreign 
corporations. 

12.  Miscellaneous  income  or  income  from  other 
sources. 

13.  Dividends  on  stocks  and  interest  on  second  Lib- 
erty Bonds. 

(a)  Received  directly. 

(b)  Received  through  partnership. 

(c)  Received  through  fiduciaries. 


48  INCOME   AND  FEDERAL    TAX    REPORTS 

SALARIES,  WAGES  AND   COMMISSIONS 

Salaries,  wages  and  commissions. — Our  first  subdivision 
of  gross  income  is  salaries,  wages  and  commissions  and 
other  compensation  of  the  individual  during  the  year. 
As  has  been  indicated,  salaries  of  officers  or  employees 
of  the  State  or  of  any  political  subdivision  of  the  State 
and  of  certain  federal  officials  are  exempt  from  taxa- 
tion and  need  not  be  included  in  the  report. 

The  compensation  may  be  in  cash  or  its  equivalent. — The 
compensation  of  an  individual  need  not  be  money;  it 
may  take  the  form  of  living  quarters,  light,  board,  use 
of  special  privileges,  etc.  The  value  of  such  extra  com- 
pensation should  be  calculated  or  determined  and  in- 
cluded in  the  return  as  part  of  the  salary  or  compensa- 
tion. The  Treasury  Department  has  stated  that  where 
an  individual  is  provided  with  living  quarters  in  addi- 
tion to  his  salary,  the  rental  value  of  the  living  quar- 
ters is  regarded  as  compensation  subject  to  the  income 
tax. 

In  some  cases  it  is  difficult  to  determine  whether  or 
not  the  granting  of  special  privileges  is  part  of  the 
compensation.  Furnishing  a  salesman  with  the  use  of 
a  car  for  business  purposes  would  not  be  compensation, 
even  though  he  is  permitted  to  use  the  car  for  per- 
sonal purposes.  The  test  of  whether  any  particular 
item  is  received  as  compensation  and  therefore  re- 
turnable in  the  report  is  this:  "Is  the  item  in  lieu  of 
some  non-deductible  expense,  such  as  ordinary  living 
expenses,  that  would  otherwise  be  incurred?"  If  it  is 
in  lieu  of  such  non-deductible  expense  it  should  be  in- 
cluded as  income  to  the  extent  of  the  expense  that 
would  otherwise  be  incurred.  For  example :  A  is  an  em- 
ployee living  in  a  suburban  town.  Commutation  to  his 
place  of  business  amounts  to  $100  a  year.  If  A  is  given 
a  pass  over  a  railroad  or  is  furnished  with  an  automobile 
to  go  to  and  come  from  his  business,  he  should  report 


INDIVIDUAL   INCOME    TAX  49 

the  pass  or  use  of  the  automobile  as  income  to  the  ex- 
tent of  $100. 

Quarters,  mileage  and  expense  of  government  officers  and 
employees. — The  Treasury  Department  has  issued  the 
following  instructions  to  government  officers  and  em- 
ployees : 

"When  quarters  are  furnished  of  a  less  number  of 
rooms  than  the  number  allowed  by  law,  the  money 
equivalent  only  of  the  number  of  rooms  actually  as- 
signed shall  be  returned  as  income.  When  quarters  are 
furnished  of  a  greater  number  of  rooms  than  the  num- 
ber allowed  by  law,  it  is  to  be  assumed  that  the  excess 
number  is  assigned  for  the  convenience  of  the  Govern- 
ment, and  the  money  equivalent  only  of  the  number  of 
rooms  allowed  by  law  shall  be  returned  as  income." 

Heat  and  light. — Amounts  received  by,  or  paid  for, 
an  officer  for  heat  and  light  shall  be  returned  as  income. 
"This  includes  the  money  equivalent,  as  fixed  by  the 
Government,  of  heat  and  light  furnished  to  an  officer 
occupying  public  quarters  (for  residence  purposes)." 

Mileage. — The  difference  between  the  amount  received 
as  mileage  and  the  amount  of  actual  necessary  expenses 
incurred  on  a  journey  is  to  be  returned  as  income.  The 
actual  expenses  to  be  deducted  by  the  individual  before 
ascertaining  his  gain,  profit,  or  income  on  account  of 
mileage  are  the  expenses  for  which  reimbursement 
would  be  made  by  the  government  if  he  had  traveled 
on  an  actual  expense  basis  instead  of  on  a  mileage 
basis. 

Reimbursement  for  actual  expenses. — Amounts  re- 
ceived from  the  government  to  reimburse  the  individual 
for  subsistence  and  other  items  of  actual  expenses  in- 
curred while  absent  on  business  for  the  government  are 
not  required  to  be  reported  as  income. 

The  difference  between  the  amount  received  as  a  per 
diem  allowance  and  the  amount  of  actual  necessary  ex- 


50         INCOME   AND  FEDERAL    TAX    REPORTS 

penses  incurred  on  a  journey  must  be  reported  as  in- 
come. 

Voluntary  offerings  received  by  clergymen  should  be  con- 
sidered as  income. — Easter  offerings,  and  fees  received 
by  clergymen  for  funerals,  masses,  marriages,  baptisms, 
etc.,  are  considered  income  subject  to  tax  under  the  pro- 
visions of  the  Income  Tax  law,  and  must  be  reported. 
Christmas  gifts,  however,  are  not  considered  income 
within  the  meaning  of  the  law  and  should  not  be  in- 
cluded in  a  return.  The  theory  probably  is  that  all  in- 
come except  the  Christmas  gifts  are  earnings,  while 
the  Christmas  gifts  are  in  the  nature  of  gratuities. 

Compensation  of  the  trustee  of  any  estate  should  be  re- 
turned as  income  for  the  year  in  which  received. — If  the 
amount  due  the  trustee  of  any  estate  as  compensation 
for  his  services  over  a  period  of  years  is  not  deter- 
mined until  the  trust  is  terminated,  the  amount  the 
trustee  is  allowed  should  be  return  in  full,  as  income 
for  the  year  in  which  it  is  paid.  It  should  not  be  pro- 
rated over  the  length  of  time  during  which  he  served 
as  trustee.  But  if  the  trustee  can  show  that  part  of 
this  fee  has  been  definitely  earned  prior  to  March  1, 
1913,  that  part  of  the  fee  will  be  exempt  from  the  tax 
and  need  not  be  reported.  This  rule  also  applies  to 
administrators  and  executors  of  an  estate. 

Expense  allowances. — Where  an  individual  receives,  in 
addition  to  his  salary  or  commissions,  an  allowance  for 
traveling  or  other  expenses,  there  should  be  included  as 
income  any  difference  between  the  allowance  and  the 
amount  actually  paid  for  these  expenses. 

The  entire  allowance  may  be  included  as  income  un- 
der the  heading  miscellaneous  income,  and  the  amount 
of  expenses  actually  paid  may  be  included  in  the  deduc- 
tions as  necessary  expenses,  or  simply  the  difference 
may  be  reported. 

Salaries  paid  by  exempt  organizations  are  not  exempt 
from   the   income   tax. — Salaries   paid   by   corporations, 


INDIVIDUAL    INCOME    TAX  51 

which  have  been  held  to  be  exempt  from  the  income  tax, 
are  subject  to  the  income  tax  and  should  be  returned 
as  income  by  the  individuals  receiving  them.  For  ex- 
ample, the  salary  of  an  individual  employed  by  a  char- 
itable institution  would  not  be  exempt,  though  he  is  em- 
ployed by  an  exempt  organization. 

Bonuses. — If  special  payment  is  made  to  an  employee 
and  is  a  gratuity  or  voluntary  payment,  for  which  no 
service  is  rendered,  the  amount  so  paid  may  be  con- 
sidered as  a  gift  and  need  not  be  reported  as  income 
received.  However,  any  bonus  or  other  item  of  com- 
pensation paid  to  an  employee  in  addition  to  his  regu- 
lar salary  or  wages  as  additional  compensation  for 
services  actually  rendered,  as  a  reward  for  past  en- 
deavors, or  as  a  stimulus  to  further  zeal  and  enthu- 
siasm in  the  discharge  of  his  duties,  is  held  to  consti- 
tute taxable  income,  which  should  be  reported  under 
gross  income  in  the  employee's  report.  The  circum- 
stances under  which  such  bonuses  will  be  considered  as 
being  for  services  rendered  are  discussed  more  fully 
under  allowable  deductions  for  corporations.  Wher- 
ever the  employer  may  deduct  from  its  income  pay- 
ments such  as  bonuses  to  employees,  the  employee  must 
report  the  amount  so  received  as  income.  Whenever 
the  employer  is  not  permitted  to  make  such  a  deduc- 
tion, the  employee  need  not  report  the  amount  received. 
Christmas  remembrances,  anniversary  gifts,  etc.,  from 
an  employer  to  an  employee  do  not  constitute  such 
items  as  are  considered  taxable  income,  and  need  not 
be  reported  as  income  by  the  employee. 

Commissions  received  should  be  reported  as  income. — 
Commissions  received  by  salesmen  are  income  and 
must  be  reported  in  the  tax  return  of  the  salesman. 

Commissions  received  on  renewal  premiums  for  insur- 
ance are  income  when  received,  and  must  be  reported 
in  the  period  in  which  they  are  received.  It  follows 
that  a  commission  retained  by  a  life  insurance  agent  on 


52         INCOME   AND  FEDERAL    TAX    REPORTS 

his  own  life  insurance  policy  is  income  accruing  to  the 
agent,  and  must  be  included  in  his  personal  return  of 
income. 

Professional  and  vocational  fees. — The  services  of  a 
professional  man  are  usually  of  such  a  nature  as  to  be 
compensated  by  fees,  or  else  of  such  a  nature  that  no 
portion  of  the  amount  becomes  due  until  the  service  is 
completed.  In  such  a  case  the  total  amount  of  the 
compensation  should  be  included  in  the  return  for  the 
year  in  which  the  compensation  is  received.  However, 
if  the  person  making  the  report  keeps  his  books  on  an 
accrual  basis,  he  may  report  his  income  during  the 
year  in  which  the  fee  becomes  due,  even  though  it  is 
not  received  until  a  later  year.  If  subsequently  any 
of  these  fees  should  prove  uncollectible  they  may  be  de- 
ducted as  bad  debts  in  the  year  in  which  they  are  found 
uncollectible. 

INCOME  FROM  BUSINESS,   TRADE,   OR  FARM 

Income  from  business,  trade,  or  farm. — Our  third  sub- 
division of  gross  income  is  income  received  from  busi- 
ness, trade,  or  farm. 

If  an  individual  is  engaged  in  business  or  trade,  con- 
ducted by  him  as  a  sole  proprietor,  or  is  the  owner  of 
a  farm,  he  should  report  the  total  amount  of  cash  re- 
ceived from  the  sale  of  merchandise  or  farm  products 
for  the  calendar  year,  regardless  of  the  time  of  closing 
of  the  books  of  his  business. 

If  the  individual  keeps  books  upon  the  "accrual" 
basis  he  may  report  the  amount  of  income  "accrued," 
that  is,  earned  but  not  yet  received,  instead  of  the 
amount  of  cash  received.  As  against  this  he  may  de- 
duct expenses  incurred  but  not  yet  paid.  If  the  income 
is  reported  on  a  cash  basis,  only  the  expenses  actually 
paid  may  be  deducted.  The  individual  may  not  report 
his  income  on  one  basis  and  his  expenses  on  another. 

The  cash  received  from  the  sale  of  merchandise  is, 


INDIVIDUAL    INCOME    TAX  53 

manifestly,  not  all  profit,  as  neither  the  cost  of  the 
merchandise  sold  nor  the  expenses  of  the  business 
have  been  considered.  Accountants  make  a  distinction 
between  "gross"  profit,  which  is  the  profit  on  the  sale 
of  merchandise,  and  "net"  income,  which  is  the  profit 
after  deducting  the  expenses  of  the  business.  The 
method  of  arriving  at  gross  profit  as  used  by  account- 
ants is  illustrated  by  the  following  example: 

Sales    $100,000 

Inventory    at    the    beginning    of    the 

year $30,000 

Add  purchases 90,000 

Total    $120,000 

Less  inventory  at  end  of  year $40,000 

Cost  of  goods  sold 80,000 

Gross  profit  on  sales $20,000 

To  ascertain  the  net  income  of  this  business,  all  other 
expenses,  such  as  rent  and  labor,  would  be  deducted 
from  the  gross  profit  on  sales. 

A  form  provided  by  the  Treasury  Department  for 
the  return  of  net  income  of  individuals  does  not  make 
this  same  distinction  between  gross  profit  and  net  in- 
come. The  form  provides  for  the  stating  of  the  total 
receipts  as  gross  income  and  for  the  deduction  of  the 
various  expenses,  such  as  labor,  rent,  depreciation, 
etc.  (all  of  which  are  covered  in  detail  in  a  later  sec- 
tion of  this  book).  In  the  form,  merchandise  purchased 
is  included  among  the  expenses  to  be  deducted,  and  no 
provision  is  made  for  stating  the  inventories  at  the  be- 
ginning and  at  the  end  of  the  year.  The  amount  of 
purchases,  as  may  be  seen  by  the  illustration  used 
above,  does  not  of  necessity  represent  the  cost  of  the 
merchandise  sold.    The  cost  of  merchandise  sold  is  de- 


54  INCOME   AND  FEDERAL    TAX   REPORTS 

termined  by  adding  to  the  purchases  the  inventory  at 
the  beginning  of  the  year  and  subtracting  from  the  re- 
sulting figure  the  inventory  at  the  end  of  the  year. 
The  net  result  of  the  transaction  is  to  add  to  purchases 
the  decrease  in  the  inventory  or  to  subtract  from  pur- 
chases the  increase  in  the  inventory.  In  the  illustra- 
tion just  used  the  inventory  at  the  end  of  the  year 
shows  an  increase  of  $10,000.  This  means  that  of  the 
$90,000  worth  of  merchandise  purchased  $10,000  was 
not  sold.  Deducting  $10,000  from  $90,000  we  have  the 
cost  of  the  merchandise  sold,  or  $80,000.  In  the  form 
provided  by  the  Treasury  Department  this  latter  figure 
should  be  stated  as  the  merchandise  purchased  for  re- 
sale, and  should  be  deducted  from  the  income  of  the 
business.  See  also  Chapter  on  "Eeturn  and  Computa- 
tion of  Tax,"  pp.  142  and  148. 

Valuation  of  inventories. — The  most  usual  and  by  far 
the  most  conservative  business  and  accounting  practice 
is  to  value  inventories  either  at  cost  or  at  market, 
whichever  is  lower.  In  past  years  the  attitude  of  the 
Treasury  Department  was  not  in  accord  with  this  prac- 
tice, the  Department  insisting  that  the  inventory  of 
goods  on  hand  be  valued  at  cost,  without  regard  to  any 
change  in  market  value.  Eecently,  however,  the  posi- 
tion of  the  department  has  been  modified  so  as  to  per- 
mit the  valuation  of  inventories  either  at  cost,  or  at  cost 
or  market,  whichever  is  lower.  The  effect  of  this  de- 
cision is  discussed  at  length  under  Corporations  in  a 
later  chapter. 

Practical  considerations  governing  inventory  valuation. — 
While  the  new  decision  gives  every  merchant  the  op- 
tion of  deducting  from  his  taxable  income  any  loss  he 
may  have  sustained  due  to  a  decrease  in  the  market 
value  of  his  merchandise  or  stock  inventory,  it  is  not 
always  advisable  for  the  merchant  to  exercise  this  op- 
tion. It  is  well  to  bear  in  mind  that  the  inventory  fig- 
ure reported  at  the  end  of  one  year  must  be  used  as 


INDIVIDUAL    INCOME    TAX  55 

the  inventory  figure  at  the  beginning  of  the  following 
year.  It  is  obvious,  therefore,  that  any  deduction  from 
inventory  valuations  one  year  will  be  reflected  in  the 
following  year's  report,  showing  a  corresponding  in- 
crease in  the  income  for  the  following  year. 

Therefore,  it  is  often  better  (to  save  taxes  in  a  sub- 
sequent year)  to  value  inventories  at  cost,  even  when 
market  value  is  lower.  Obviously,  this  is  true  when, 
even  if  the  inventories  are  valued  at  cost,  no  profit 
will  be  shown.  The  loss  in  inventory  value  can  then  be 
deducted  in  some  subsequent  year  (when  the  goods  are 
sold  below  the  cost),  and  diminish  the  taxable  profits 
for  that  year. 

Moreover,  if  the  profits  are  small  this  year,  and 
much  larger  profits  are  anticipated  the  following  year, 
it  would  probably  save  super-taxes,  or  excess  profits 
taxes,  in  the  later  year  to  inventory  the  goods  at  cost 
this  year. 

But  if  the  company  cannot  afford  to  pay  much  in 
taxes  this  year,  it  should  inventory  its  goods  at  market 
price  (if  market  price  is  lower  than  cost)  so  as  to  keep 
down  its  taxable  profits  this  year.  The  effect  of  val- 
uing inventories  at  market  price,  when  that  is  lower 
than  cost,  is  to  decrease  taxable  profits  for  the  current 
year,  and  practically  to  increase  taxable  profits  for  a 
future  year. 

From  a  taxpayer's  standpoint  it  is  often  advisable 
to  ask  himself  the  following  question:  "Should  I  in- 
ventory my  goods  at  market  price,  and  thus  save  taxes 
this  year,  and  take  a  risk  on  next  year's  taxes,  or  at 
cost,  assuming  my  profits  will  be  larger  or  the  tax  rate 
will  be  greater  next  year?" 

Inventory  at  end  of  fiscal  year. — If  an  individual's 
gross  profit  from  business  is  determined  by  an  inven- 
tory taken  at  the  end  of  a  fiscal  year  other  than  the 
calendar  year  he  must  estimate  his  profits  for  part  of 
the  year  so  as  to  comply  with  the  Department's  regu- 


56  INCOME    AND  FEDERAL    TAX    REPORTS 

lations  requiring  him  to  report  his  gross  income  for 
the  calendar  year.  To  illustrate:  A  takes  inventory 
and  closes  his  books  November  30.  In  making  his  re- 
turn for  the  10  taxable  months  of  1913,1  he  took  nine- 
twelfths  of  his  income  for  the  fiscal  year  December  1, 

1912,  to  November  30,  1913,  and  then  estimated  the 
profits  for  the  remaining  month  (i.e.,  December,  1913) 
of  the  calendar  year.  The  next  year  he  took  the  dif- 
ference between  the  income  for  the  full  fiscal  year  and 
the  estimated  income  for  the  month  of  December,  1913, 
and  then  added  a  new  estimated  figure  for  December, 
1914. 

This  method  would  be  followed  each  year.  In  deter- 
mining his  gross  income  for  the  calendar  year  1917,  A 
would  take  his  gross  income  for  the  fiscal  year  ending 
November  30,  1917,  deduct  the  amount  estimated  in  pre- 
paring the  return,  as  the  gross  income  for  the  month 
of  December,  1916,  and  add  to  the  resulting  figure  the 
estimated  profit  for  the  month  of  December,  1917. 

Unless  a  perpetual  inventory  has  been  kept  it  will  be 
necessary  to  estimate  the  gross  income  for  the  period 
between  the  close  of  the  fiscal  year  and  the  close  of  the 
calendar  year.  The  only  reasonable  method  is  to  assume 
that  the  percentage  of  gross  profit  on  sales  for  the  period 
in  question  is  the  same  as  that  actually  determined  for 
the  preceding  fiscal  year. 

Business  need  not  be  lawful. — The  law  of  1913  levied 
a  tax  on  the  gains  from  any  lawful  business.  But  the 
law  of  1916  levies  a  tax  on  the  gains  from  "business, 
trade,  etc.,"  and  the  law  does  not  specifically  mention 
"lawful"  businesses  or  trades.  This  would  indicate  that 
even  though  the  business  is  of  an  unlawful  nature  the 
gains  or  profits  should  be  reported. 

Income  from  partnership. — Income  from  partnership 
interest   in  a  business   should  not  be   reported  under 

i  The  income  tax  law  of  October  3,  1913,  levied  a  tax  on  the  income  of 
individuals  for  the  10  months  only,  from  March  1,  1913,  to  December  31, 

1913,  because  the  sixteenth  amendment  did  rot  become  effective  until 
February  28,  1913. 


INDIVIDUAL   INCOME    TAX  57 

this  caption,  inasmuch  as  it  is  reported  under  a  separate 
caption.     (See  "Partnership  Income,"  p.  71.) 

Other  income. — Income  derived  from  the  sale  of  or 
from  dealings  in  property  should  be  reported  under 
this  caption.  If  part  of  the  business  income  is  derived 
from  interest,  rents,  royalties  or  dividends,  such  items 
should  be  shown  under  their  respective  captions. 

Partially  completed  contracts. — If  an  individual  enters 
into  a  contract  in  1917  which  will  not  be  completed 
until  1918,  and  he  is  unable  to  determine  what  amount 
of  gain  or  profit  he  will  derive  from  the  contract  until 
its  completion,  any  payments  received  thereon  during 
1917  need  not  be  included  as  income  for  that  year. 
Neither  will  the  expenses  incurred  up  to  that  time  be 
included  as  a  deduction.  When  the  contract  is  com- 
pleted in  1918,  the  net  gain  or  profit  derived  therefrom 
should  be  reported  in  the  return  for  that  year. 

Appreciation  of  book  value  of  capital  assets  is  not  in- 
come.— Any  appreciation  in  the  value  of  assets  due  to 
reappraisal  or  adjustment  and  so  recorded  on  the  books 
of  the  individual  or  corporation  is  not  income  until 
such  appreciation,  as  a  result  of  a  completed  and  closed 
transaction,  has  been  converted  into  cash  or  its  equiva- 
lent. Until  any  appreciation  taken  up  on  the  books  has 
been  so  realized,  it  will  not  be  considered  income. 
Hence,  in  the  preparation  of  returns  and  in  the  ex- 
amination of  books  for  the  purpose  of  verifying  the 
same,  mere  book  entries  of  appreciation  in  the  value  of 
capital  assets  will  be  disregarded.  But  in  the  event 
of  the  sale  of  the  assets,  the  increase  in  whose  value 
was  previously  taken  up  on  the  books,  the  profit  or  in- 
come to  be  reported  (i.e.,  the  taxable  income)  as  a  re- 
sult of  the  sale  will  be  determined  upon  the  basis  of 
the  difference  between  the  cost  and  the  selling  price  of 
the  assets;  that  is  to  say,  in  the  case  of  a  sale,  book 
values  will  be  ignored  except  as  such  book  values  rep- 
resent the  actual  cost  of  the  properties.    For  example, 


58         INCOME   AND  FEDERAL    TAX   REPORTS 

an  individual  has  a  building  which  cost  $100,000.  Dur- 
ing the  year  1916  an  entry  was  made  raising  the  value 
to  $200,000,  thereby  creating  a  book  profit  of  $100,000. 
This  profit  should  not  be  included  in  income  for  the 
year  1916.  During  1917  the  property  was  actually  sold 
for  $175,000.  The  books  of  the  individual  for  1917 
show  a  loss  of  $25,000.  For  the  purpose  of  the  income 
tax  he  must  disregard  his  book  figures  and  go  back  to 
the  original  cost.  The  measure  of  profit  is  the  differ- 
ence between  the  original  cost  and  the  selling  price,  or 
$75,000,  which  should  be  reported  as  income  for  1917. 
If  the  building  was  purchased  prior  to  March  1,  1913, 
the  measure  of  profit  is  the  increase  in  fair  market 
value  above  the  fair  market  value  as  of  March  1,  1913. 

Non-resident  aliens — method  of  determining  profits  from 
business  in  the  United  States. — A  non-resident  alien,  as 
has  been  explained  hereinbefore,  is  required  to  report 
only  such  income  as  arises  from  sources  within  the 
United  States.  If  the  business  from  which  the  non- 
resident alien  derives  profit  is  conducted  entirely  within 
the  United  States,  there  is  no  question  but  that  the  en- 
tire profits  from  the  business  should  be  included  as 
income  from  within  the  United  States. 

The  phrase  "from  sources  within  the  United  States" 
is  very  broad  and  would  include  the  income  from  busi- 
nesses which  maintain  a  selling  office  in  the  United 
States  or  which  even  send  a  salesman  here.  In  such 
cases  the  profit  on  the  orders  taken  in  the  United  States 
must  be  reported.  Where  a  separate  record  of  the  cost 
of  the  goods  has  not  been  kept,  the  only  fair  method  is 
to  presume  that  the  same  percentage  of  profit  is  made 
on  business  done  in  the  United  States  as  is  made  on 
the  total  business  transacted.  If  the  foreign  individual 
does  a  total  business  of  $1,000,000,  of  which  $100,000  is 
in  the  United  States,  if  the  total  cost  of  doing  this 
business  is  $800,000,  the  profit  to  be  reported  as  from 
the  United  States  is  the  same  per  cent  of  the  business 


INDIVIDUAL  INCOME   TAX  59 

done  in  the  United  States  as  the  total  profit  is  of  the 
total  business.  In  this  case  the  total  profit  is  $200,000, 
or  20  per  cent.  The  profit  from  sources  within  the 
United  States  would  be  20  per  cent  of  $100,000,  or 
$20,000.  If  this  method  is  used  the  special  expenses 
incurred  in  the  United  States  cannot  be  deducted,  as 
they  have  already  been  included  in  determining  the 
profit  of  the  entire  business. 

PROFIT  FROM    SALE   OF  LAND,   BUILDINGS  AND   OTHER 
PROPERTY 

Profit  from  sale  of  real  estate  is  subject  to  tax. — For  in- 
come tax  purposes,  where  there  has  been  an  actual  sale 
and  transfer,  profit  will  be  considered  as  realized  even 
though  payment  is  to  be  made  in  installments;  it  is 
held  that  notes  for  deferred  payments,  secured  by  the 
title  of  the  property,  and  bearing  interest,  are  worth  in 
cash,  presumably,  their  face  value.  Therefore,  the  en- 
tire profits  realized  by  individuals  from  the  sale  of  real 
estate  or  other  property  will  be  taxable  except  where 
the  property  in  connection  with  which  the  profit  is  ob- 
tained was  acquired  prior  to  March  1,  1913,  and  in  that 
case  the  profit  will  be  the  difference  between  the  sell- 
ing price  and  the  fair  market  value  of  the  property  as 
of  March  1,  1913.  But  where  lots  are  sold  on  a  monthly 
installment  basis,  and  title  remains  in  the  seller  until 
the  last  payment  is  made,  and  where  a  fixed  amount  is 
received  each  month  in  payment  of  the  total  purchase 
price,  the  monthly  installment  received  must  be  consid- 
ered part  profit  and  part  cost.  For  example,  let  it  be 
supposed  that  A  sells  10  lots  for  $400  each,  receiving 
$100  down  and  $5  a  month  on  each  lot.  Let  it  be  sup- 
posed, further,  that  the  cost  of  each  lot,  including  cost 
of  improvements,  sewers,  walks,  etc.,  was  $300,  and 
that  the  cost  of  the  10  lots  sold  was  $3,000.  One-fourth 
of  the  sale  price,  therefore,  is  profit.  It  would  be  nec- 
essary  to   consider  three-fourths   of   every   dollar  re- 


60  INCOME   AND  FEDERAL    TAX   REPORTS 

ceived  in  payment  as  cost  and  to  consider  one-fourth 
as  profit.  Thus,  if  $2,400  had  been  received  on  account 
of  the  sale  price  of  these  lots,  the  profit  to  be  returned 
would  be  $600. 

Appreciation  and  depreciation  of  good-will. — Good-will, 
for  income  tax  purpose,  is  capable  neither  of  apprecia- 
tion nor  of  depreciation,  and  should  be  eliminated  from 
any  calculations  of  income.  A  book  entry  setting  a 
value  upon  the  good-will  and  thereby  creating  a  surplus 
should  be  ignored  in  the  preparation  of  the  income  tax 
report.  Therefore,  any  stock  dividend  declared  out  of 
surplus  which  consists  merely  of  an  increased  value 
placed  on  the  good-will  of  a  corporation  is  not  being 
paid  from  earnings  of  the  corporation  and  would  not 
be  income  to  the  recipient.  But,  if  an  individual  sells 
his  good-will  or  stock  dividend,  the  sum  received  for  it 
would  be  shown  in  the  increased  price  he  receives  for 
his  assets  and  would  be  included  as  income,  as  being  a 
profit  on  the  sale  of  the  assets. 

How  to  ascertain  profits  on  stock  transactions. — When 
stock  is  purchased  for  a  price  lower  than  the  market 
price  at  the  time  of  reporting  yearly  income,  such  in- 
crease should  not  be  considered  as  profit,  inasmuch  as 
it  is  only  an  appreciated  value  on  the  books  of  the  re- 
porting individual  and  is  not  an  established  profit  due 
to  a  completed  transaction.  Thus,  if  stock  is  purchased 
on  March  10th  at  90  and  is  retained  by  the  purchaser, 
and,  on  the  December  31st  following,  the  stock  is  sell- 
ing in  the  open  market  at  95,  the  5-point  market  in- 
crease will  be  disregarded  and  not  reported  as  income. 
On  the  other  hand,  if  stock  is  purchased  at  90  and  is 
actually  sold  during  the  year  for  95,  the  5-point  gain 
must  be  reported  as  income.  Of  course,  in  the  first  case, 
if  the  stock  is  sold  in  some  subsequent  year  at  95,  the 
5-point  gain  must  be  reported  in  the  year  of  the  sale 
of  the  stock. 

When  various  parcels  of  stock  of  the  same  issue  are 


INDIVIDUAL  INCOME   TAX  61 

bought  and  sold  at  different  dates,  the  shares  sold, 
whenever  possible,  should  be  identified  by  the  number 
of  the  certificates  covering  them.  When  stock  is  sold, 
and  its  identity  cannot  be  determined,  it  should  be 
charged  against  the  stock  first  purchased  and  remaining 
unsold.  Thus,  on  March  20th  A  buys  100  shares  of 
Southern  Pacific  stock  at  83.  This  stock  is  represented 
by  certificate  No.  1037.  On  April  10th,  A  buys  100 
more  shares  of  the  same  company  at  89.  These  shares 
are  represented  by  certificate  No.  2419.  On  June  10th 
A  sells  certificate  No.  2419,  representing  100  shares  of 
Southern  Pacific,  at  90.  In  this  case  A  reports  a  profit 
from  the  transaction  of  $100.  But  if  A  did  not  have  a 
record  of  the  numbers  of  the  certificates  representing 
the  shares  he  would  have  to  report  a  profit  of  $700,  for 
the  profit  would  then  have  to  be  charged  against  the 
stock  first  purchased. 

Exchange  of  securities  through  reorganization.  —  The 
Treasury  Department  has  held  that  no  profit  or  loss 
will  be  taken  into  consideration  for  the  purpose  of  the 
income  tax  unless  it  has  been  realized  as  a  result  of  a 
closed  and  completed  transaction.  A  closed  and  com- 
pleted transaction  is  defined  as  one  in  which  an  asset 
is  disposed  of  for  cash  or  for  assets  other  than  cash  at 
a  fixed  or  determined  value  at  the  time  the  transaction 
is  consummated. 

Where  an  individual  holds  the  securities  of  a  cor- 
poration and  as  a  result  of  a  reorganization  he  ex- 
changes his  securities  for  the  securities  of  the  new  cor- 
poration, the  question  arises  as  to  whether  such  an  ex- 
change is  a  closed  and  completed  transaction  under  the 
above  definition.  If  it  is  held  to  be  a  completed  trans- 
action, what  is  the  measure  of  the  profit  or  loss  to  be 
reported?  The  attitude  of  the  Department  formerly 
was  that  such  transactions  were  merely  an  exchange  in 
kind  and  that  no  profit  or  loss  could  be  determined 
until  the  new  securities  were  actually  sold.    The  meas- 


\ 


62  INCOME   AND  FEDERAL    TAX    REPORTS 

ure  of  profit  or  loss  would  then  be  the  difference  be- 
tween the  price  realized  for  the  new  securities  and  the 
cost  (or,  where  the  stocks  were  purchased  prior  to 
March  1,  1913,  the  value  at  that  date)  of  the  original 
securities. 

However,  it  was  later  held  that,  for  income  tax  pur- 
poses, where  securities  in  one  company  were  exchanged 
for  securities  in  a  reorganized  company,  the  transaction 
would  be  treated  as  a  sale  of  the  original  securities,  and 
the  profit  or  loss  would  be  the  difference  between  the 
value  of  the  old  stock  March  1,  1913  (or  date  of  pur- 
chase subsequent  to  that  date),  and  the  value  at  which 
the  same  stock  was  given  in  exchange  for  the  new  stock. 
In  the  particular  case  before  the  Commissioner  the 
stock  of  the  New  York  Title  Insurance  Company  was 
exchanged  for  stock  of  the  New  York  Title  and  Mort- 
gage Company  at  $50  per  share;  that  is,  for  each  $100 
par  value  of  stock  in  the  old  Title  Insurance  Company 
there  was  given  $50  par  value  of  stock  in  the  new  Title 
and  Mortgage  Company.  The  assets  were  placed  upon 
the  books  of  the  new  company  at  approximately  the 
same  figure  as  that  at  which  they  were  carried  by  the 
old  company,  thereby  creating  a  surplus  upon  the  books 
of  the  new  company,  and  a  portion  of  such  surplus  was 
then  marked  off  by  reason  of  the  depreciation  in  mar- 
ket value  of  the  old  stock  below  the  book  value.  The 
Commissioner  held  that  this  constituted  a  closed  trans- 
action and  that  the  stockholders  of  the  old  New  York 
Title  Insurance  Company  could  deduct  as  a  loss  the 
difference  between  the  cost  price  of  the  stock  (the  mar- 
ket price  March  1,  1913,  if  the  stock  was  purchased 
prior  to  that  date)  and  $50  per  share,  to  the  extent  that 
such  losses,  however,  did  not  exceed  gains  from  other 
similar  transactions  during  the  same  year. 

This  position,  which  has  been  since  modified,  offered 
a  loophole  for  fraud.  To  illustrate:  Company  A,  with 
assets    of   $100,000    and    a    capital    stock   of   $100,000 


INDIVIDUAL  INCOME   TAX  63 

(1,000  shares),  sells  its  assets  to  company  B  for  the  en- 
tire capital  stock  (500  shares,  par  $100)  of  company  B, 
which  it  distributes  to  its  own  stockholders.  Stockhold- 
ers of  company  A  receive  only  $50  of  new  capital  stock 
for  each  $100  of  the  old  stock.  Under  the  ruling  just 
cited  the  stockholders  would  be  allowed  to  deduct  as  a 
loss,  subject  to  the  limitations  on  losses  hereinafter  de- 
scribed, the  difference  between  the  cost  of  the  stock 
and  $50.  Actually  no  loss  has  been  incurred.  Company 
B  has  exactly  the  same  assets  that  company  A  had. 
Each  stockholder  has  the  same  proportionate  share  of 
these  assets  as  before  the  reorganization. 

Completed  transaction  defined. — In  August,  1917,  the 
Treasury  Department  took  the  position  that  in  the  sale 
or  disposition  of  capital  assets  a  closed  and  completed 
transaction  is  held  to  be  one  in  which  an  asset  is  dis- 
posed of  for  cash  or  for  assets  other  than  cash  at  a 
fixed  or  determined  value,  that  is,  for  cash  or  its 
equivalent  in  value  at  the  time  the  transaction  is  con- 
summated. If  the  assets  are  exchanged  for  other  assets 
of  a  like  character,  and  no  account  is  taken  of  compen- 
satory value,  it  will  be  held  that  such  a  transaction 
constitutes  merely  a  change  in  the  form  of  assets,  and 
the  investment  will  be  considered  a  continuing  one,  no 
profit  or  loss  to  be  taken  into  account  until  the  assets 
are  disposed  of  for  cash  or  its  equivalent. 

This  attitude  appears  to  be  sounder  than  the  one 
taken  in  the  second  case  cited  and  will  no  doubt  be 
maintained  by  the  Department. 

Sale  of  rights  to  subscribe  to  stock.  —  Income  received 
from  the  sale  of  rights  to  subscribe  to  new  stock  in  a 
corporation  in  which  a  person  is  a  stockholder  must 
be  included  in  his  report.  If  the  rights  are  not  sold, 
but  are  permitted  to  lapse  or  are  used  to  acquire  stock 
of  the  company,  it  would  seem  that  they  in  no  way 
affect  the  income  of  the  reporting  individual.    At  least 


64  INCOME    AND  FEDERAL    TAX    REPORTS 

that  seems  at  present  to  be  the  attitude  of  the  Treas- 
ury Department. 

Profits  on  sale  of  securities. — When  stock  was  pur- 
chased prior  to  March  1,  1913,  the  method  of  determin- 
ing the  gain  to  be  reported  from  a  subsequent  sale  is 
to  take  the  difference  between  the  selling  price  and  the 
average  market  for  that  stock  on  March  1,  1913. 

How  to  determine  fair  market  price  of  stock  as  of  March 
1,  1913,  when  subsequently  sold. — The  fair  market  price 
or  value  as  of  March  1,  1913,  is  held  to  be  as  of  the 
entire  day  of  March  1,  1913,  and  in  case  of  a  variation 
between  "opening  and  closing  price"  the  fair  value 
would  be  determined  by  taking  the  average  price  for 
the  day.  This  is  conditioned,  however,  upon  the  show- 
ing by  the  taxpayer  that  the  "Exchange"  quotation 
represented  the  fair  market  price  or  value  of  the  stock, 
as  it  is  this  "fair  market  price  or  value"  which  is  to 
control,  in  whatever  manner  that  fact  may  be  ascer- 
tained. 

Computing  profits  on  sales  of  securities  left  by  decedent. 
— If  securities  are  sold  by  the  beneficiary  at  a  price 
greater  than  the  appraised  value  placed  upon  them  in 
the  settlement  of  the  estate,  the  gain  in  value  is  in- 
come of  the  beneficiary  subject  to  tax,  and  such  gain 
must  be  included  in  the  report  of  the  beneficiary. 

If  securities  belonging  to  an  estate  are  sold  prior  to 
the  settlement  of  the  estate  by  the  administrators  or 
trustees  at  a  price  greater  than  their  appraised  value 
as  of  the  date  of  the  decedent's  death,  the  amount  of 
gain  derived  from  the  transaction  is  considered  income 
accruing  to  the  estate  and  subject  to  income  tax,  and 
should  be  included  in  the  return  filed  by  the  adminis- 
trator. 

Profits  from  sale  of  property  acquired  by  gift  are  subject 
to  tax. — As  previously  stated,  all  profits  derived  from 
the  sale  of  property  acquired  by  gift  are  subject  to  the 
tax.     This  profit  is  the  difference  between  the  selling 


INDIVIDUAL  INCOME   TAX  65 

price  and  the  appraised  or  fair  value  of  the  property 
at  the  time  of  receiving  the  gift,  or  its  fair  value  as  of 
March  1,  1913,  if  the  gift  was  received  before  that  date. 
It  must  be  remembered  that  the  gift  itself  is  not  con- 
sidered income  when  it  is  received  by  the  donee,  nor  is 
it  deductible  from  the  income  of  the  donor. 

Profits  derived  from  sale  or  exchange  of  farm  products. 
— All  income  derived  from  the  sale  or  exchange  of  farm 
products,  whether  produced  on  the  farm  or  purchased 
and  resold  by  a  farmer,  is  income  for  the  year  in  which 
the  products  were  actually  marketed  and  sold. 

A  farmer  is  not  required  to  report  as  income  the 
value  of  the  farm  produce  which  he  raises  and  which 
is  consumed  by  himself  and  family;  and  any.  expense 
incurred  in  producing  such  products  so  consumed  can- 
not be  claimed  as  an  expense  of  this  business.  If  a 
farmer  exchanges  his  produce  for  merchandise,  grocer- 
ies, etc.,  or  in  any  manner  disposes  of  his  produce  in 
other  ways  than  by  selling  it,  he  should  include  as  in- 
come the  regular  price  placed  upon  the  goods  so  ex- 
changed for  the  produce,  or  if  no  exchange  price  has 
been  agreed  upon,  then  the  fair  market  value  of  the 
goods  received  in  exchange  for  his  produce. 

Rents  received  in  crop  shares  are  income  in  the  year 
during  which  the  crop  shares  are  reduced  to  money  or 
a  money  equivalent.  For  example,  if  A,  the  land 
owner,  has  the  right  to  one-third  of  the  crop,  the  other 
two-thirds  going  to  the  party  who  supplies  the  seed, 
implements  and  labor,  the  owner,  A,  would  not  report 
his  share  of  the  crop  till  he  had  sold  it  or  consumed  it. 

The  exemption  from  the  tax  of  farm  products  con- 
sumed applies  only  to  those  products  raised  by  a  farmer 
and  consumed  by  himself  and  his  family;  it  does  not 
apply  to  farm  products  acquired  as  crop  shares  or 
through  barter. 

The  above  rulings  apply  only  to  those  who  cultivate  or 
manage  farms  for  gain  or  profit. — A  person  cultivating  or 


66  INCOME   AND  FEDERAL    TAX   REPORTS 

operating  a  farm  for  recreation  or  pleasure,  on  a  basis 
other  than  one  in  accordance  with  the  recognized  prin- 
ciples of  commercial  farming,  the  result  of  which  oper- 
ations is  a  continual  loss  from  year  to  year,  is  not  re- 
garded as  a  farmer.  In  such  cases,  if  the  expenses  in- 
curred in  connection  with  the  farm  are  in  excess  of  the 
receipts  therefrom,  the  entire  receipts  from  sale  of 
products  should  be  ignored  in  rendering  a  return  of 
income;  and  the  expenses  incurred,  being  regarded  as 
personal  expenses,  will  not  constitute  allowable  deduc- 
tions in  the  return  of  income  derived  from  other  sources. 

RENTS 

Rent  may  be  returnable  as  income  for  year  in  which  re- 
ceived.— Eent  is  the  gain  or  profit  which  accrues  to 
the  owner  of  a  piece  of  property  from  the  tenant  for 
the  use  of  that  property.  In  a  case  where  rent  is  not 
paid  during  the  year  for  which  it  applies,  the  landlord 
may  include  in  his  return  of  annual  net  income  only  the 
rents  actually  paid  to  him  within  the  year.  For  ex- 
ample, the  rent  paid  on  January  5,  1918,  for  the  months 
of  November  and  December,  1917,  may  be  reported  as 
income  for  the  year  1918,  or,  if  the  landlord  so  de- 
sires, he  may  report  the  rent  as  of  the  date  when  it 
actually  became  due  and  payable,  provided  he  keeps 
his  books  of  accounts  on  the  accrual  basis  and  not  upon 
the  cash  basis,  as  hereinbefore  explained.     (See  p.  46.) 

Where  property  is  handled  through  an  agent,  who 
remits  to  the  owner  the  net  proceeds  after  paying  taxes 
and  expense,  the  owner  should  report  the  total  amount 
of  rents  collected  by  the  agent,  and  under  expenses  take 
credit  for  the  expenses  paid  by  the  agent. 

Board,  lodging,  crops  and  other  consideration  received  in 
lieu  of  cash  for  rent  is  income. — If  an  owner  of  a  piece 
of  property  rents  it  and  receives  as  rent  his  board  or 
lodging  or  a  share  of  the  crops  raised  on  the  property, 
the  value  of  the  board  or  lodging  or  share  of  the  crops 


INDIVIDUAL  INCOME  TAX  67 

is  considered  income  and  therefore  should  be  included 
in  the  return  of  net  income.  If  the  tenant  works  prop- 
erty on  shares,  the  landlord  should  report  the  money 
received  from  the  sale  of  the  crops  in  the  year  in  which 
they  are  sold. 

Tenants'  improvements  are  income  to  the  owner  of  the 
property. — Where  a  tenant  under  the  provisions  of  a 
lease  erects  a  building  or  makes  an  improvement  which 
reverts  to  the  owner,  it  must  be  reported  as  income  by 
the  owner  of  the  property  at  the  expiration  of  the  lease. 
The  amount  of  gain  or  profit  is  the  difference  between 
the  cost  of  the  building  or  improvement  and  a  reason- 
able allowance  for  the  exhaustion,  wear  and  tear  of  the 
property. 

INTEREST 

Interest  is  returnable  as  income  in  the  year  received. — 
Interest  on  notes,  ordinary  mortgages,  and  corporate 
and  other  obligations  should  be  entered  on  the  annual 
return  for  the  year  in  which  such  payments  were  re- 
ceived, unless  books  have  been  kept  on  an  accrual 
basis. 

Interest  which  accrued  prior  to  March  1,  1913,  but 
which  is  paid  in  the  current  year  is  not  taxable. 

Interest  on  bonds  of  the  second  Liberty  Loan  and  on 
War  Saving  Certificates  in  excess  of  $5,000  par  value 
should  also  be  reported.  This  interest  is  exempt  from 
the  normal  tax  and  also  from  the  super-tax,  but  from 
the  latter  only  to  the  extent  of  the  interest  on  $5,000 
par  value  of  bonds  or  certificates.  Interest  on  the  Sy2 
per  cent  Liberty  Bonds  is  not  to  be  reported  as  income, 
since  these  bonds  are  not  subject  to  any  income  tax. 

Interest  on  bank  deposits  must  be  returned  as  income. — 
Interest  paid,  or  accrued  and  unpaid,  must  be  included 
in  the  annual  income  return  of  the  person  entitled  to 
receive  such  interest,  whether  on  open  account  or  on  a 
certificate  of  deposit. 


G8  INCOME   AND  FEDERAL    TAX    REPORTS 

Interest  accrued  on  bonds  at  time  of  purchase  and  sale. 
— Interest  accrued  on  bonds  at  time  of  purchase  and 
sale  should  be  reported  by  the  vendor  and  not  by  the 
vendee.  Where  the  purchaser  of  bonds  pays,  in  addi- 
tion to  the  price  of  the  bonds,  the  amount  of  accrued 
interest,  he  should  include  in  his  return  only  such  in- 
terest as  has  been  earned  after  the  purchase.  In  such 
a  case  the  vendor  considers  as  income  the  interest 
which  has  accrued  on  the  bonds  up  to  the  time  of  their 
sale.  For  example,  A  owns  one  $1,000  X  6  per  cent 
bond,  interest  payable  January  1  and  July  1.  On 
April  1,  A  sells  the  X  bond  to  B  for  $1,000  plus  ac- 
crued interest,  i.e.,  $1,030.  In  that  case  A  must  report 
as  income  the  $30  interest  accrued  on  the  bond  up  to 
April  1,  when  it  was  sold  to  B.  B  will  receive  an  in- 
terest check  of  $60  on  July  1.  Only  $30  of  this  need 
be  reported,  for  only  $30  interest  was  earned  on  the 
bond  after  B  purchased  it,  i.e.,  between  April  1  and 
July  1. 

Bonds  purchased  at  a  premium. — When  a  6  per  cent 
bond  which  has  10  years  to  run  to  maturity  is  pur- 
chased at  119  (i.e.,  for  $1,190),  the  real  income  from 
the  bond  is  not  $60.  Some  business  men  might  con- 
sider only  the  fact  that  they  receive  $60  each  year  as 
interest  and  lose  sight  of  the  fact  that  at  the  end  of 
the  10  years  they  will  receive  only  $1,000  for  the  bond 
which  cost  $1,190.  This  means  a  loss  of  $190.  Insur- 
ance companies  and  other  concerns  which  own  a  large 
number  of  bonds  would  distribute  this  loss  over  the 
life  of  the  bond  so  that  their  interest  account  would 
show  an  annual  income  on  this  bond  of  $41  instead  of 
$60.* 

To  protect  himself,  the  individual  investor  should 
follow  the  example  of  these  concerns.  If  he  were  to 
report  the  income  as  $60  each  year,  he  would  have  to 

i  For  the  scientific  method  of  "amortization,"  as  this  process  is  called. 
see  Sprague's  "Investment  Accounting." 


INDIVIDUAL  INCOME   TAX  69 

deduct  as  a  loss  at  the  end  of  the  tenth  year  the  dif- 
ference between  $1,190  and  $1,000,  or  $190.  This  loss 
would  then  be  regarded  by  the  Treasury  Department  as 
a  "loss  incurred  in  transaction  other  than  from  busi- 
ness," and  subject  to  the  limitations  imposed  by  the 
Department  on  the  deduction  of  such  losses. 

Bonds  purchased  at  a  discount. — When  bonds  are  pur- 
chased at  a  discount,  the  real  income  of  the  holder  of 
the  bond  is  more  than  the  bond  interest  rate.  For  ex- 
ample, a  10-year,  6  per  cent  $1,000  bond,  bought  at 
$800,  gives  the  purchaser  not  only  an  income  of  $50  a 
year,  but  also  a  profit  of  $200  at  the  end  of  10  years, 
representing  the  difference  between  what  the  purchaser 
pays  for  the  bond,  $800,  and  what  he  receives  from  the 
corporation  at  the  end  of  10  years,  $1,000,  which  is  the 
par  value  of  the  bond.  This  profit  of  $200  may  be  ap- 
portioned over  the  life  of  the  bond  and  an  equal  part 
of  the  profit  reported  as  income  during  each  of  the  ten 
years,  or  the  entire  $200  profit  may  be  reported  at  the 
end  of  ten  years.  Under  the  first  method,  the  holder 
of  the  bond  would  report  each  year  an  income  of  $70, 
representing  $50,  the  interest  received  from  the  cor- 
poration, plus  $20,  one-tenth  of  the  $200  discount.1 
Under  the  second  method  the  holder  of  the  bond  would 
report  an  income  of  $50  each  year  for  9  years,  and  an 
income  of  $250  in  the  tenth  year. 

It  must  be  remembered,  however,  that  if  the  premium 
is  written  off  over  the  life  of  the  bond  the  discount 
on  bonds  must  also  be  treated  in  the  same  manner. 
If  the  individual  were  to  write  off  the  premium  on  his 
bonds  and  not  accumulate  the  discount  his  records 
would  not  reflect  his  true  income  and  would  not  be  ac- 

3  If  the  scientific  method  of  figuring  the  amortization  of  the  discount 
were  used,  the  holder  of  the  bond  would  report  an  annual  income  of  only 
$65.90,  i.e.,  $50  plus  $15.90.  for  $15.90  laid  aside  during  each  of  the  ten 
years  and  earning  5  per  cent  interest  (the  interest  rate  of  the  bond)  would 
amount  to  $200  at  the  end  of  10  years. 


70  INCOME   AND  FEDERAL    TAX    REPORTS 

cepted  by  the  Department  because  of  the  inconsistency 
of  his  accounting  methods. 

Interest  on  bonds  received  by  legatee. — The  ruling — that 
accrued  interest  must  be  apportioned  between  a  buyer 
and  a  seller  of  a  bond  in  proportion  to  the  length  of 
the  interest  period  during  which  each  was  the  owner 
of  the  bond — does  not  apply  to  the  interest  on  bonds 
received  by  a  legatee.  The  legatee  is  required  to  re- 
turn as  income  the  full  amount  of  interest  received  by 
him  on  a  bond,  notwithstanding  the  fact  that  a  part  of 
the  first  coupon,  payable  after  he  received  it,  has  been 
added  to  the  bond  and  included  in  the  gross  estate  of 
the  decedent,  thereby  becoming  taxable  under  the  Estate 
Tax  law. 

Interest  on  certain  public  obligations  taxable. — Where  a 
municipality  purchases  a  public  utility  subject  to  a  mort- 
gage, the  income  from  which  is  taxable,  the  mortgage 
retains  its  original  character  even  though  the  municipal- 
ity assumes  the  mortgage  indebtedness  and  pays  the 
interest  on  it.  The  interest  on  such  obligations,  accord- 
ingly, is  taxable  income. 

Interest  from  bonds  of  exempt  organizations  should 
be  considered  as  income  subject  to  tax.  The  fact  that 
a  corporation,  joint-stock  company  or  association  is 
exempt  from  the  income  tax  does  not  exempt  the  inter- 
est on  its  obligations  from  the  tax  when  received  by  an 
individual  or  corporation  subject  to  the  tax. 

Fiduciaries. — Income  received  from  fiduciaries  includes 
all  income  received  from  guardians,  trustees,  executors, 
administrators,  receivers,  conservators,  or  other  persons 
acting  in  a  fiduciary  capacity. 

Such  part  of  the  income  received  from  fiduciaries  as 
represents  dividends  from  domestic  corporations  should 
not  be  included  under  the  heading  of  "interest,"  but 
should  be  shown  separately  under  the  heading  of  "divi- 
dends received  through  fiduciaries."  This  separation  is 
necessary  in  order  that  the  amount  of  such  dividends 


INDIVIDUAL  INCOME  TAX  71 

may  be  deducted  in  computing  the  normal  tax.  In  or- 
der to  do  this  the  beneficiary  should  obtain  from  the 
fiduciary  a  report  of  the  income  and  expenditures  of 
the  estate  so  that  he  may  determine  how  much  of  his 
share  is  from  dividends  or  from  non-taxable  sources. 
Such  part  of  the  beneficiary's  income  as  is  from  non- 
taxable sources  should  be  omitted  from  his  return 
entirely. 

PARTNERSHIP  INCOME 

Partnership  gains  and  profits. — No  return  is  required 
of  partnerships  as  such.  Each  member  of  a  partner- 
ship should  report,  as  an  individual,  his  share  of  the 
net  profits  of  the  partnership. 

Limited  partnerships  are  held  to  be  corporations, 
for  the  purpose  of  the  income  tax,  and  in  their  or- 
ganized capacity  are  subject  to  the  income  tax  as  cor- 
porations. The  individual  members  of  the  limited  part- 
nership should  report  their  share  of  the  profits  in  the 
same  manner  as  that  in  which  they  report  dividends 
on  stock  of  corporations.  The  same  rule  also  applies 
to  members  of  a  joint-stock  company. 

When  income  from  partnership  accrues. — The  Income 
Tax  law  of  September  8,  1916,  section  8,  subdivision 
(e),  provides  that  "Persons  carrying  on  business  in 
partnership  shall  be  liable  for  income  tax  only  in  their 
individual  capacity,  and  the  share  of  the  profits  of  the 
partnership  to  which  any  taxable  partner  would  be  en- 
titled if  the  same  were  divided,  whether  divided  or  oth- 
erwise, shall  be  returned  for  taxation  and  the  tax  paid 
under  the  provisions  of  this  title." 

The  income  from  a  partnership  accrues  to  the  indi- 
vidual partner  at  the  time  his  distributable  interest  is 
determined  and  reduced  to  possession.  The  member  of 
a  partnership  should  include  in  his  return  his  interest 
in  the  partnership  profits  ascertained  at  the  end  of  the 
business    year   falling    within    the    calendar   year    for 


72  INCOME    AND  FEDERAL    TAX    REPORTS 

which  his  return  is  rendered.  Such  share  of  profits 
should  not  be  again  included  in  the  return  when  it  is 
actually  paid  to  the  partner.  To  illustrate:  A  is  a 
member  of  a  partnership  whose  fiscal  year  ends  Jan- 
uary 31.  His  share  of  the  profits  of  the  partnership 
for  the  fiscal  year  ending  January  31,  1917,  should  be 
included  in  his  report  of  income  for  the  year  1917,  and 
any  moneys  actually  received  by  him  in  1918  from  the 
earnings  of  the  partnership  for  the  fiscal  year  ending 
January  31,  1917,  will,  therefore,  not  be  reported  by 
him  as  income  for  the  year  1918. 

Partnership  profits  taxed  at  rates  in  effect  in  year  in 
which  they  were  earned. — Section  8,  paragraph  (e),  of 
the  Income  Tax  law,  as  amended  October  3,  1917,  pro- 
vides that:  "A  partnership  shall  have  the  same  privi- 
lege of  fixing  and  making  returns  upon  the  basis  of  its 
own  fiscal t  year  as  is  accorded  to  corporations  under 
this  title.  If  a  fiscal  year  ends  during  1916  or  a  subse- 
quent calendar  year  for  which  there  is  a  rate  of  tax 
different  from  the  rate  for  the  preceding  calendar 
year,  then  (1)  the  rate  for  such  preceding  calendar 
year  shall  apply  to  an  amount  of  each  partner's  share 
of  such  partnership  profits  equal  to  the  proportion 
which  the  part  of  such  fiscal  year  falling  within  the 
calendar  year  bears  to  the  full  fiscal  year,  and  (2)  the 
rate  for  the  calendar  year  during  which  such  fiscal 
year  ends  shall  apply  to  the  remainder."  In  the  illus- 
tration in  the  preceding  paragraph  eleven-twelfths  of 
A's  share  of  the  profits  of  the  partnership  which  he 
reported  for  1917  is  subject  to  the  tax  at  the  rates  in 
effect  for  the  calendar  year  1916.  The  remaining  one- 
twelfth  is  taxable  at  the  rates  in  effect  for  1917. 

The  section  of  the  law  quoted  above  was  not  in  the 
Income  Tax  law.  of  September  8,  1916,  but  is  included 

i  A  fiscal  year  of  a  business  concern  is  its  twelve  months'  business  period, 
which  may  or  may  not  coincide  with  the  calendar  year.  In  the  Income  Tax 
law  the  use  of  the  term  "fiscal  year"  implies  that  the  year  in  question  does 
not  coincide  with  the  calendar  year. 


INDIVIDUAL  INCOME   TAX  73 

in  the  amendment  of  October  3,  1917.  The  Department 
had  therefore  taxed  all  partnership  profits  included 
in  the  1916  returns  at  the  rates  in  effect  for  the  cal- 
endar year  1916.  This  new  section  of  the  law,  how- 
ever, is  retroactive  to  1916,  and  therefore  affects  the 
1916  returns.  Individuals  who  included  in  their  1916 
returns  profits  from  a  partnership  for  a  fiscal  year  part 
of  which  fiscal  year  fell  within  the  calendar  year  1915, 
it  appears,  are  entitled  to  a  refund  of  the  difference 
between  the  tax  as  assessed  under  the  1916  rates  and 
the  amount  which  should  have  been  assessed  under  the 
1915  rates,  on  such  proportion  of  the  profits  from  the 
partnership  as  should  have  been  taxed  only  at  the  1915 
rates.  To  refer  to  the  previous  illustration,  A  in  his 
report  of  income  for  the  calendar  year  1916,  which  he 
filed  on  or  before  March  1,  1917,  included  his  share  of 
the  partnership  profits  for  the  fiscal  year  ended  Jan- 
uary 31,  1916.  His  income  was  taxed  at  the  rates  fixed 
for  the  calendar  year  1916.  According  to  the  amended 
provisions  of  the  law  he  should  have  been  taxed  at  the 
1915  rates  on  eleven-twelfths  of  his  income  from  the 
partnership.  He  should  make  application  for  a  refund 
for  the  difference  between  what  he  was  assessed  and 
what  he  should  have  been  assessed.1 

Non-taxable  income  of  partnership  to  be  omitted  from 
returns  of  partners. — Any  non-taxable  items  of  income, 
such  as  interest  on  State,  municipal  or  government 
bonds,  including  Liberty  Bonds  of  the  first  issue,  or 
the  bonds  into  which  they  are  converted,  but  excepting 
interest  on  second  Liberty  Bonds,2  should  be  deducted 

i  The  method  of  obtaining  a  refund  is  discussed  on  p.  27. 

2  Interest  on  bonds  of  the  second  liberty  loan  is  not  entirely  free  from 
the  income  tax.  It  is  free  from  the  normal  tax,  but  is  free  from  the  super- 
tax only  to  the  extent  of  the  interest  on  $5,000  par  value  of  the  bonds. 

No  tax  is  levied  upon  a  partnership  as  an  entity,  the  tax  being  upon  the 
members  of  the  partnership.  Each  partner  will  report  his  share  of  the  net 
profits  of  the  partnership,  including  the  interest  on  the  Liberty  Bonds 
of  the  second  issue  in  excess  of  the  interest  on  more  than  $5,000  par  value 
of  such  bonds.    The  interest  on  the  principal,  $5,000  or  less  of  Liberty  4s, 


74  INCOME   AND  FEDERAL    TAX    REPORTS 

by  each  of  the  individual  partners  from  his  share  of 
the  partnership  profits.  Such  income  is  exempt  from 
tax  even  though  the  bonds  are  deposited  as  collateral 
to  secure  loans  the  interest  on  which  is  deducted  as  a 
business  expense  by  the  partnership. 

Dividends  should  be  shown  separately. — Each  partner 
should  show  his  share  of  dividends  received  by  the  part- 
nership under  a  separate  caption,  i.e.,  "Dividends  Re- 
ceived from  Partnership."  If  he  includes  such  divi- 
dends under  partnership  profits  he  will  not  be  allowed 
to  deduct  them  in  computing  the  normal  tax. 

Returns  may  be  required  of  partnerships. — Though  part- 
nerships are  not  taxable  as  such,  the  Commissioner  of 
Internal  Eevenue  has  power  to  require  any  partner- 
ship to  file  a  report  of  its  net  profits,  with  a  statement 
of  its  members,  their  names  and  addresses,  and  their 
respective  interests  in  the  net  profits  earned. 

Determining  net  profits  of  a  partnership. — The  net  profits 
to  be  reported  by  an  individual  partner  should  be  his 
share  of  the  net  profits  of  the  partnership  as  shown  by 
its  books,  less  the  deductions  allowed  an  individual  in 
a  similar  business. 

The  amount  of  losses  which  may  be  deducted  by  a 
partnership  is  subject  to  the  same  restrictions  as  that 
placed  upon  individuals.  Therefore,  in  determining  the 
net  profit  of  a  partnership  that  does  not  own  a  mem- 
bership in  a  stock  exchange,  or  if  dealing  in  securi- 
ties is  not  a  part  of  its  regular  business,  losses  actually 
sustained  in  stock  transactions  entered  into  for  profit 

is  not  taxable  and  need  not  be  reported. 

The  member  of  a  partnership  which  owns  Liberty  Bonds  will  be  regarded 
as  an  individual  owner  of  an  amount  of  bonds  proportionate  to  his  interest 
in  the  partnership.  Thus  if  the  partnership,  composed  of  three  equal  part- 
ners, owns  $6,000  of  Liberty  Bonds,  each  member  is  regarded  as  owning 
$2,000  of  the  bonds,  and  the  interest  is  not  reportable  or  taxable.  If,  how- 
ever, such  a  member  himself  owns  additional  Liberty  Bonds,  not  included 
in  the  partnership  assets,  in  an  amount  sufficient  to  make  his  individual  and 
partnership  holdings  together  as  much  as  $5,000  or  more,  he  must  report 
and  pay  taxes  on  interest  on  bonds  which  he  holds  in  excess  of  the  principal 
amount  of  $5,000. 


INDIVIDUAL  INCOME  TAX  75 

may  be  deducted  in  an  amount  not  exceeding  the  profits 
derived  from  similar  transactions  entered  into  for  profit. 
If  a  partnership,  however,  is  engaged  in  the  busi- 
ness of  purchasing  and  selling  securities,  or  if  it  owns 
a  membership  in  a  stock  exchange,  the  full  amount  of 
losses  sustained  on  such  transactions  may  be  deducted.1 

INTEREST   ON  BONDS  AND   DIVIDENDS  ON   STOCK  ISSUED   IN 
FOREIGN  COUNTRffiS 

Interest  on  bonds  and  dividends  on  stock  issued  in  for- 
eign countries. — Interest  on  bonds,  deeds  of  trust,  notes 
and  other  similar  interest-bearing  obligations  issued  in 
foreign  countries  must  be  reported  in  full  by  citizens 
and  resident  aliens,  but  need  not  be  reported  by  non- 
resident aliens,  even  though  the  securities  on  which  the 
interest  is  paid  are  physically  present  in  the  United 
States. 

Dividends  on  stock  of  foreign  corporations,  joint- 
stock  companies  or  associations  or  insurance  companies 
which  are  engaged  in  business  in  foreign  countries 
should  also  be  reported  as  income. 

Where  the  entire  net  income  of  a  foreign  corpora- 
tion is  from  sources  within  the  United  States,  the  divi- 
dends on  the  stock  of  such  a  corporation  are  treated  in 
like  manner  as  are  the  dividends  on  stock  of  a  domes- 
tic corporation  and  may  be  deducted  in  computing  the 
normal  tax.  Such  dividends,  in  order  to  be  deductible, 
should  therefore  be  included  under  the  caption  "divi- 
dends received  from  domestic  corporations." 

If  only  part  of  the  net  income  of  the  corporation  is 
from  sources  within  the  United  States,  the  dividends 
on  the  stock  of  the  corporation  will  be  treated  as  if 
the  corporation  were  entirely  engaged  in  business 
abroad  and  will,  therefore,  not  be  allowed  as  a  deduc- 
tion in  computing  the  normal  tax. 

Foreign  income  not  remitted  to  United  States. — Where  the 
interest  on  bonds  or  dividends  on  the  stock  of  a  for- 

i  See  Chapter  on  Deductions,  p.  120. 


76  INCOME   AND  FEDERAL    TAX    REPORTS 

eign  corporation  owned  by  a  resident  American  citizen 
is  credited  to  his  account  abroad  but  not  remitted  to 
the  United  States  he  should  return  the  income  at  the 
rate  of  exchange  prevailing  at  the  time  it  was  credited 
to  him. 

On  the  other  hand,  if  the  income  is  neither  credited 
to  him  abroad,  nor  received  by  him  here,  the  resident 
American  citizen  need  not  report  the  income,  which  he 
could  obtain  if  he  wished  to,  unless  he  keeps  his  books 
on  an  accrual  basis.  This  would  apply,  for  example, 
in  the  case  of  a  resident  American  citizen  owning  some 
foreign  corporation  or  Government  coupon  bonds,  the 
interest  on  which  is  payable  only  on  surrender  of  the 
coupon.  If  the  American  citizen  did  not  clip  his  cou- 
pon and  send  it  abroad  for  payment,  and  if  it  were  not 
paid  during  1917,  he  would  not  be  compelled  to  report 
the  value  of  the  -coupon  as  income,  until  he  collected  it. 

SPECIAL   SOURCES   OF  INCOME 

Royalties  from  mines,  oil  wells,  patents,  franchises  and 
other  legalized  privileges  are  returnable  as  income. — In 
the  case  of  mines  operated  by  a  lessee  on  a  royalty 
basis,  the  lessor,  in  disposing  of  his  ores  or  natural  de- 
posits, is  receiving  back  part  of  his  capital  due  to  the 
depletion  of  the  mine.  The  lessor  should  report  the 
total  royalty  received  as  income,  and  deduct  a  proper 
amount  representing  the  actual  depletion  of  the  prop- 
erty.1 

Amount  received  from  sale  of  royalty  and  patent  rights 
is  returnable  as  income  after  deducting  cost. — In  the  sale 
of  a  patent  or  of  royalties,  where  all  rights  and  title 
to  the  patent  are  surrendered,  the  amount  received  for 
such  a  sale,  less  the  aggregate  amounts  expended  in 
perfecting  the  invention  and  obtaining  the  patent,  is 
income.  If  only  the  right  to  manufacture  and  sell 
under  a  patent  is  sold,  the  total  amount  of  the  price 

i  The  question  of  depletion  of  mines  and  oil  wells  is  considered  in  the 
chapter  on  Corporation  Deductions,  p.  233. 


INDIVIDUAL  INCOME   TAX  77 

received  for  the  right  is  income.  The  owner  of  the  pat- 
ent will,  however,  be  allowed  to  deduct  a  reasonable 
allowance  for  the  depreciation  of  the  patent.1 

Pensions. — Pensions  received  from  any  private  source 
or  from  the  United  States  Government  must  also  be 
reported  as  income  subject  to  taxation.  But  pensions 
received  by  an  employee  of  a  State  or  any  political 
subdivision  of  a  State,  for  services  rendered  to  the 
State  or  its  political  subdivision,  are  exempt  and  need 
not  be  reported. 

Damages  recovered. — Damages  recovered  through  law- 
suits or  settlements,  less  the  lawyers'  fees  and  all  ex- 
penses incurred  incident  to  the  suit  or  claim,  must  be 
reported  as  income.  In  the  case  of  a  recovery  of  dam- 
ages for  personal  injuries,  for  example,  lawyers'  fees, 
doctors'  bills,  medical  bills,  the  cost  of  medicines,  and 
all  other  expenses  incurred  should  be  deducted  from 
the  amount  of  the  judgment  collected,  and  only  the  net 
amount  should  be  reported. 

Accident  insurance  and  employees'  accident  compensa- 
tion.— Money  received  by  a  person  from  accident  in- 
surance, less  all  insurance  premiums  paid  for  the  in- 
surance and  less  all  expenses  incurred  as  a  result  of  the 
accident,  should  also  be  reported  as  taxable  income. 
The  expenses  which  may  be  deducted,  in.  addition  to 
insurance  premiums,  are  mentioned  in  the  preceding 
paragraph.  Only  the  net  amount  should  be  reported  as 
income.  The  same  rules  apply  to  money  received  by  a 
person  from  his  employer  or  an  insurance  company 
under  State  or  Federal  accident  compensation  laws. 

It  must  be  borne  in  mind  that  the  proceeds  of  acci- 
dent insurance  policies  or  the  accident  compensation 
paid  upon  the  death  of  the  person  insured  to  the  bene- 
ficiaries will  be  treated  the  same  as  the  proceeds  of 
life  insurance  policies,  heretofore  discussed. 

i  See  chapter  on  Corporation  Deductions,  p.  230. 


78         INCOME   AND  FEDERAL    TAX   REPORTS 

Income  from  bad  debts  charged  off  in  a  previous  period. 
— If  payments  are  received  on  account  of  debts  charged 
off  as  bad  debts  in  previous  years  they  must  be  in- 
cluded as  income  during  the  current  year.  This  is  the 
ruling,  even  though  such  bad  debt  was  charged  off 
prior  to  March  1,  1913. 

Alimony. — The  Treasury  Department  has  held  that 
alimony  is  income  and  must  be  reported  as  such  (T.  D. 
2090).  A  recent  decision  in  the  Supreme  Court  (Gould 
vs.  Gould,  decided  November  19,  1917)  holds  that  ali- 
mony in  the  hands  of  the  recipient  is  not  subject  to 
the  income  tax,  nor  is  it  a  deductible  item  of  expense  of 
the  payor. 

DIVIDENDS 

Dividends. — Under  this  heading  should  be  included 
dividends  received  from  domestic  corporations,  joint- 
stock  companies  or  associations  and  insurance  companies 
and  from  foreign  corporations  whose  entire  net  income 
is  derived  from  sources  within  the  United  States.  The 
dividends  should  be  classified  according  to  their  source 
into: 

1.  Dividends  received  directly  from  corporations. 

2.  Dividends  received  through  fiduciaries. 

3.  Dividends  received  through  partnerships. 
Dividends  are  exempt  from  the  normal  tax,  and  are 

therefore  subject  only  to  the  super-taxes.  Individuals 
having  an  income  of  less  than  $5,000  are  not  taxed  on 
income  received  in  the  form  of  dividends.  The  reason 
for  exempting  dividends  from  the  normal  tax  is  that 
the  income  represented  by  the  dividends  has  been  taxed 
when  earned  by  the  corporation,  and  therefore  should 
not  be  taxed  again  when  distributed  to  the  stock- 
holder. All  dividends  received,  unless  specifically  ex- 
empt from  all  income  taxes  (see  following  pages)  must 
be  included  in  the  return.  In  calculating  the  normal 
tax,  the  amount  of  dividends  should  be  deducted.1 

i  See  the  chapter  on  Eeturns  and  Computation  of  Tax,  p.  158. 


INDIVIDUAL  INCOME   TAX  79 

It  is  important  that  any  dividends  included  as  in- 
come as  received  through  fiduciaries  or  through  a 
partnership  be  shown  on  the  report  as  dividends,  in 
order  that  such  amount  may  be  deducted  in  computing 
the  normal  tax. 

Income  received  from  private  banks  considered  as  divi- 
dend.— In  the  case  of  private  banks  which  have  the  form 
of  corporations  and  which  are  held  to  be  associations 
within  the  meaning  of  the  Federal  Income  Tax  Law, 
the  income  which  the  members  of  the  association 
receive  from  the  bank  because  of  their  investments 
will  be  considered  dividends. 

Taxes  paid  by  bank  for  owners  of  bank  stock  consid- 
ered a  dividend. — Taxes  assessed  against  the  stock- 
holders of  a  bank  and  paid  by  the  bank  in  their  behalf 
are  considered  an  additional  dividend  to  the  amount  of 
the  taxes  paid  and  should  be  included  in  the  returns 
of  the  individual  stockholders. 

Dividends  from  paid-up  policies  considered  income.  — 
Dividends  from  paid-up  insurance  policies  are  con- 
sidered income  to  the  recipient,  and  must  be  included 
in  the  annual  return  of  income.  They  are  considered 
the  same  for  the  purpose  of  the  tax  as  dividends  or 
net  earnings  from  corporations. 

Record  owner  of  stock  is  not  to  include  dividend  in 
return  if  stock  is  owned  by  another. — The  record  owner 
of  stock  is  not  required  to  include  in  the  income  tax 
return  any  amount  of  dividends  received  on  stock  that 
actually  belongs  to  another.  But  if  a  question  should 
be  raised  as  to  why  dividends  on  stock  recorded  in 
the  name  of  an  individual,  firm  or  corporation  are 
not  included  in  the  record  owner's  income  tax  return, 
such  owner  will  be  required  to  show  conclusively  that 
the  actual  ownership  of  the  stock  rested  with  another. 

Profits  of  limited  partnerships  considered  dividends. — 
The  profits  of  limited  partnerships,  which  make  returns 
in   the    same   manner   as    corporations   make    returns, 


80  INCOME   AND  FEDERAL    TAX    REPORTS 

will  be  treated  as  dividends  of  corporations  and  must 
be  reported  in  the  returns  of  individual  members  in 
the  same  manner  as  are  dividends  upon  the  stock  of 
corporations.  That  is  to  say,  members  of  a  limited 
partnership  report  only  so  much  of  the  profits  as 
they  receive  (like  stockholders  of  a  corporation),  and 
not  their  undistributed  share  of  the  profits  (like  part- 
ners in  a  general  partnership). 

Dividends  declared  from  reserves. — Where  a  corpora- 
tion declares  a  dividend  out  of  surplus  created  by 
crediting  reserves  which  were  previously  set  aside  to 
meet  depreciation  and  depletion  of  property,  such  divi- 
dends constitute  income  to  the  stockholders  and  must 
be  reported  as  income  if  the  reserves  were  accumu- 
lated subsequent  to  March  1,  1913.  But  if  the  re- 
serves were  created  prior  to  March  1,  1913,  the  divi- 
dends need  not  be  included  as  income.  In  the  latter 
case,  if  the  stock  on  which  the  dividends  were  paid 
is  sold,  in  calculating  the  profit  on  the  sale  of  the  stock 
the  dividends  must  be  subtracted  from  the  original  pur- 
chase price,  and  the  difference  subtracted  from  the  sell- 
ing price  of  the  stock.  In  calculating  the  loss,  if  any, 
on  the  sale  of  the  stock,  the  selling  price  is  subtracted 
from  the  cost  minus  the  dividends  mentioned. 

Dividends  paid  from  surplus  created  by  revaluation  of 
assets  are  not  income. — As  any  surplus  created  by  a  book 
appreciation  of  assets  is  not  income  to  the  corporation, 
so  the  dividends  paid  from  such  surplus  are  not  income 
in  the  hands  of  the  stockholders.  The  same  rule  holds 
true  as  to  dividends  paid  from  a  surplus  created  by 
setting  up  a  good-will  account  upon  the  books  of  the 
corporation. 

If  such  dividend  is  paid  in  cash  and  the  stock  on 
which  the  dividends  were  paid  is  subsequently  sold,  the 
amount  of  these  dividends  must  be  considered  in 
determining  the  profit  or  loss  from  the  sale.  The 
amount   of  these   dividends    should   be   deducted   from 


INDIVIDUAL  INCOME   TAX  81 

the  cost,  if  the  stock  was  purchased  subsequent  to 
March  1,  1913,  or  from  the  fair  value  March  1,  1913, 
if  it  was  purchased  prior  to  that  date.  The  difference 
between  the  resulting  figure  and  the  selling  price  will 
be  the  amount  of  profit  or  loss  on  the  transaction. 

To  illustrate:  A  owns  100  shares  of  stock  which  he 
purchased  in  1916  at  $90  a  share.  In  March,  1917, 
he  received  a  dividend  of  $5  a  share,  the  dividend  being 
paid  out  of  a  surplus  created  by  revaluing  the  plant 
of  the  corporation.  In  October  he  sells  the  stock  at 
$100  a  share.  He  would  not  be  required  to  report  the 
dividend  as'  income,1  but  would  be  required  to  include 
a  profit  on  the  sale  of  the  stock  of  $1,500,  arrived  at 
as  follows: 

Cost  of  100  shares  at  $90 $9,000 

Dividend  of  $5  a  share 500 

Net  cost   $8,500 

Selling  price  of  100  shares 10,000 

Profit   $1,500 

If  the  dividend  is  paid  in  stock,  instead  of  in  cash, 
and  some  or  all  of  the  stock  is  subsequently  sold,  the 
situation  is  quite  complicated.  To  use  the  figures  of 
the  illustration  above: 

A  at  the  beginning  had  100  shares  which  cost  him 
$9,000.  He  receives  5  shares  as  a  stock  dividend,  the 
dividend  being  paid  out  of  a  surplus  created  by  re- 
valuing the  plant  of  the  corporation,  or  by  setting  up 
a  good-will  account.  He  now  has  105  shares.  What 
is  the  cost  per  share?  The  Treasury  Department  re- 
quires that  the  100  shares  and  the  5  shares  be  consid- 
ered as  separate  lots,  the  method  used  when  different 
lots  of  the  same  stock  are  purchased,  and  that  the  100 

i  He  should,  however,  attach  a  statement  to  his  return  stating  the  amount 
of  the  dividend,  and  the  reason  for  not  including  it  as  income. 


82  INCOME    AND  FEDERAL    TAX    REPORTS 

shares  cost  be  regarded  as  $90  a  share,  and  the  5  shares 
nothing.  If  we  sold  the  5  shares,  we  would  have  to 
report  the  entire  sales  price  as  income.  The  sounder 
practice  would  seem  to  be  to  consider  the  entire  105 
shares  as  one  lot  which  cost  $9,000,  or  $85.71  a  share. 
It  then  would  not  make  any  difference  how  many 
shares  are  sold;  the  profit  or  loss  would  be  the  differ- 
ence between  $85.71  per  share  and  the  selling  price. 

Dividends  need  not  be  paid  in  cash. — The  Income  Tax 
Law,  section  31(a)   states: 

"That  the  term  'dividends'  as  used  in  this  title  shall 
be  held  to  mean  any  distribution  made  or  ordered  to  be 
made  by  a  corporation,  joint  stock  company,  association 
or  insurance  company,  out  of  its  earnings  or  profits  ac- 
crued since  March  first,  nineteen  hundred  and  thirteen, 
and  payable  to  its  shareholders,  whether  in  cash  or  in 
stock ■  of  the  corporation,  joint  stock  company,  associa- 
tion, or  insurance  company,  which  stock  dividend  shall 
be  considered  income,  to  the  amount  of  the  earnings  or 
profits  so  distributed." 

Scrip  dividends. — Scrip  dividends  2  are  to  be  treated 
as  cash  dividends  to  the  face  value  of  the  scrip.  The 
transaction  is  held  to  be  a  payment  in  cash  of  the  divi- 
dend and  an  investment  of  the  cash  in  the  scrip. 

Dividends  paid  in  bonds  issued  under  Act  of  Congress 
approved  April  24,  1917. — The  fact  that  a  dividend  was 
paid  in  Liberty  Bonds  of  either  the  first  or  second  issue 
does  not  make  the  dividend  exempt  from  tax. 

Dividends  from  surplus  earned  prior  to  March  1,  1913, 
not  taxable. — The  law  as  stated  above  specifically  ex- 
empts from  the  tax  any  earnings  or  profits  accrued  prior 
to  March  1,  1913.  This  provision  first  appeared  in  the 
Income  Tax  law  of  September  8,  1916.  Prior  to  that 
time  dividends  were  taxable  as  income  when  received, 

i  See  discussion  on  stock  dividends  later  in  this  chapter,  pp.  87-98. 
2  Scrip  dividends  are  dividends  paid  in  the  form  of  promissory  notes  in- 
stead of  in  cash. 


INDIVIDUAL  INCOME   TAX  83 

regardless  of  whether  or  not  the  profits  from  which  they 
were  paid  were  earned  or  accrued  prior  to  March  1, 
1913.  This  old  ruling  was  attacked  but  was  upheld  in 
the  recent  decision  in  the  case  of  Gulf  Oil  Corporation 
v.  C.  G.  Lewellyn,  Collector,  decided  in  the  United  States 
Circuit  Court  of  Appeal,  Third  Circuit.  There  is  no 
doubt  that  under  the  present  law  any  dividends  received 
from  earnings  accrued  prior  to  March  1,  1913,  are  not 
taxable.  There  is  some  question  as  to  the  method  of 
determining  from  what  particular  earnings  a  dividend 
is  paid. 

Prior  to  August  6,  1917,  a  corporation  could  declare 
a  dividend  and  state  that  it  was  paid  out  of  surplus 
or  undivided  profits  accumulated  prior  to  March  1, 1913. 
Such  a  statement  would  be  accepted  as  cause  for  ex- 
empting such  dividends  provided  that  there  was  a  sur- 
plus on  March  1,  1913,  out  of  which  this  dividend  could 
have  been  declared.  The  50  per  cent  dividend  of  the 
American  Eadiator  Company  may  be  used  as  an  ex- 
ample :  This  dividend  was  declared  February  1,  1917, 
payable  March  15,  1917.  At  the  time  of  declaration  it 
was  stated  that  the  dividend  was  paid  out  of  surplus 
acquired  prior  to  March  1,  1913.  The  surplus  account, 
of  the  company  follows : 

Left  in 
Year  Ended  Net  Income     Dividends         Surplus      Total  Surplus 

Jan.  31, 1910..  $971,600  $610,000  $361,600  $4,526,650 

Jan.  31, 1911..  1,772,517  779,000  993,517  5,520,167 

Jan.  31, 1912..  1,312,052  825,000  487,052  6,007,220 

Jan.  31, 1913..  1,696,193  1,476,900  219,293  6,226,513 

Jan.  31, 1914..  2,081,267  1,603,590  477,677  6,704,190 

Jan.  31, 1915..  2,289,075  1,865,680  423,395  7,127,586 

Jan.  31, 1916..  2,364,593  1,519,336  845,257  7,972,843 

Jan.  31, 1917..  2,604,068  1,579,696  1,084,372  9,057,215 

Common  capital  stock  outstanding  Jan.  31, 

1917    8,185,600 

50  per  cent  dividend  March  15,  1917 4,092,800 


84  INCOME   AND  FEDERAL    TAX   REPORTS 

On  January  31,  1913,  this  corporation  had  a  surplus 
of  $6,226,513,  which  was  still  available  on  Feb.  1,  1917, 
and  which  was  enough  to  cover  the  dividend  declared. 
Stockholders  of  the  American  Radiator  Company  should 
therefore  omit  this  50  per  cent  dividend  from  their  re- 
turn. They  should,  however,  attach  a  statement  that 
the  dividend  is  omitted  because  it  was  paid  out  of  sur- 
plus acquired  prior  to  March  1,  1913. 

If  this  dividend  had  been  distributed  on  or  after  Au- 
gust 6,  1917,  the  dividend  would  be  treated  as  being  de- 
clared from  the  most  recently  accumulated  surplus  or 
undivided  profits  (Income  Tax  Law,  Sec.  31,  b.)  In 
other  words,  the  dividend  would  have  to  exhaust  first 
the  surplus  created  in  1917,  next  the  surplus  created  in 
1916,  and  so  on.  The  dividend,  instead  of  being  paid 
out  of  the  surplus  created  prior  to  March  1,  1913,  would 
be  treated  as  follows:  S 

Paid  out  of  1917  earnings    $1,084,372 

Paid  out  of  1916  earnings    845,257 

Paid  out  of  1915  earnings 423,395 

Paid  out  of  1914  earnings    477,677 

Paid  out  of  earnings  prior  to  March 

1,  1913   1,262,099 


$4,092,800 


The  holder  of  20  shares  of  the  common  stock  would 

receive  $1,000  as  a  dividend.    Of  this  $1,000,  30  8/10 

/ 12621  \ 

per  cent  I  tnnnn  T  -308  1  or  $308,  would  be   excluded 
V 40928  ./ 

from  his  return  as  earned  prior  to  March  1,  1913. 

Dividends  taxable  at  rates  in  effect  for  year  when  profits 
were  earned. — In  the  example  cited  in  the  previous  para- 
graph the  $692  calculated  to  have  been  earned  after 
March  1,  1913,  would  for  tax  purposes,  be  apportioned 
as  follows: 


INDIVIDUAL  INCOME   TAX  85 

From  1917  earnings    $265.00 

From  1916  earnings    206.50 

From  1913  to  1915  earnings   . 230.50 

Total    $692.00 

and  taxed  at  the  rates  in  effect  for  the  respective  years 
(Income  Tax  Law,  Sec.  31,  b.)  That  is,  $265  would  be 
taxed  at  the  rates  in  effect  for  1917,  $206.50  at  the  rate 
in  effect  for  1916,  and  $230.50  at  the  rate  in  effect  for 
1913  to  1915,  inclusive. 

This  represents  the  first  recognition  by  Congress 
and  the  Treasury  Department  of  the  fact  that  a  divi- 
dend declared  in  one  year  may  represent  the  earnings 
of  a  previous  year,  and  should  be  taxed  at  the  rate  for 
the  year  in  which  it  was  earned.  Prior  to  1917,  income 
from  dividends  was  taxed  at  the  rates  in  effect  when 
reported. 

It  will  be  noticed  that  the  fiscal  year  of  the  American 
Eadiator  Company  ends  January  31.  The  income  of 
the  fiscal  year  ending  January  31,  1917,  is  treated  as 
being  entirely  earned  in  1917.  The  Treasury  Depart- 
ment has  always  held  that  no  income  accrues  to  the 
corporation  until  the  close  of  the  fiscal  year  unless  the 
books  are  actually  closed  at  an  intervening  period.  If 
the  American  Radiator  Company  had  closed  its  books 
on  July  31,  1916,  the  net  income  for  that  half  year 
would  of  course  be  treated  as  earned  in  1916. 

It  must  be  remembered  that  the  date  when  the  earn- 
ings, out  of  which  the  dividend  was  paid,  were  accumu- 
lated by  the  company  declaring  the  dividend,  and  not 
the  date  when  such  earnings  were  accumulated  by  a 
subsidiary,  is  the  deciding  date  in  determining  the  rates 
at  which  the  dividend  should  be  taxed,.  To  illustrate: 
Company  A  receives  a  dividend  on  January  10,  1917, 
from  its  subsidiary,  Company  B.  The  earnings  repre- 
sented by  this  dividend  were  earned  by  Company  B  in 


86 


INCOME   AND  FEDERAL    TAX    REPORTS 


1916.  On  March  10,  1917,  Company  A  paid  a  dividend 
to  its  stockholders,  the  dividend  being  paid  out  of  the 
earnings  received  from  corporation  B.  The  stock- 
holders of  Company  A  must  pay  the  tax  at  the  rates  in 
effect  for  1917,  because  the  earnings  out  of  which  the 
dividend  was  paid  were  not  received  by  Company  A 
until  1917. 

1917  dividends  are  held  to  be  paid  out  from  the  most 
recently  accumulated  surplus. — The  law  states  that  any 
dividend  declared  in  1917  and  future  years  will  be 
treated  as  being  paid  out  of  the  most  recently  accumu- 
lated surplus  or  undivided  profits.  This  provision  does 
not  apply  to  any  dividends  which  are  stated  as  being 
paid  out  of  surplus  acquired  prior  to  March  1,  1913, 
distributed  prior  to  August  6,  1917.  To  illustrate:  The 
Bethlehem  Steel  Corporation  on  Feb.  15,  1917,  declared 
a  dividend  of  200  per  cent,  which  amounted  to 
$30,000,000. 


Surplus  Account  of  the  Bethlehem  Steel  Corporation 


Year 

Earnings           Dividends   Carried  to  Surplus 

Total  Surplus 

1916    . 

...$43,593,968  $5,502,160  $38,091,808  $69,370,198 

1915    . 

..  17,762,813     1,043,560     16,719,253 

31,278,390 

1914    . 

..     5,590,020        745,400       4,844,620 

14,559,137 

1913    . 

..     1,941,963        745,400       1,196,563 

9,714,517 

1912    .. 

. .     1,209,287                         1,209,287 

8,517,954 

1911    . 

. .     2,038,979                         2,038,979 

7,308,667 

No  statement  was  made  that  the  dividends  were  paid 
out  of  surplus  accrued  prior  to  March  1,  1913,  either  in 
whole  or  in  part.  Consequently,  the  dividends  will  be 
treated  as  paid  out  of  the  most  recent  earnings,  i.e., 
the  1916  earnings,  and  they  will  be  taxable  at  the  1916 
rates. 

The  directors  could  have  declared  $8,517,954  of  the 
dividend  paid  out  of  surplus  accumulated  prior  to 
March  1,  1913.     The  remainder  of  the  dividend,  $21,- 


INDIVIDUAL  INCOME  TAX  87 

482,046,  could  then  have  been  treated  as  having  been 
paid  out  of  the  1916  earnings.  The  directors  could  not 
claim  that  the  $21,482,046  was  paid  out  of  1915  earn- 
ings. 

SUMMARY  OF  RULES  APPLICABLE  TO   1917  DIVIDENDS 

Dividends  distributed  prior  to  August  6,  1917,  may  be 
declared  as  out  of  surplus  created  prior  to  March  1, 
1913.  If  not  specifically  declared  as  out  of  such  sur- 
plus they  will  be  treated  as  being  paid  out  of  the  most 
recently  accumulated  surplus. 

Dividends  distributed  subsequent  to  August  5,  1917, 
are  considered  as  being  paid  out  of  the  most  recently 
accumulated  surplus,  regardless  of  the  statement  ac- 
companying the  dividend. 

Stock  dividends  are  income  to  amount  of  profits  dis- 
tributed.— The  Income  Tax  Law,  section  31,  a,  referring 
to  stock  dividends,  reads  in  part :  "Which  stock  dividend 
shall  be  considered  income  to  the  amount  of  the  earn- 
ings or  profits  so  distributed."  In  T.  D.  2090,  explain- 
ing the  law,  the  Department  said:  "Stock  dividends 
included  in  a  return  of  income  should  be  accounted  for 
at  the  valuation  placed  upon  the  stock  by  the  corpora- 
tion when  said  stock  dividends  were  issued."  The  valu- 
ation placed  on  the  shares  by  the  corporation  can  be 
found  by  dividing  the  amount  of  surplus  distributed  as 
a  dividend  by  the  number  of  shares  distributed  in  pay- 
ment of  the  dividend.  To  illustrate:  a  corporation  dis- 
tributes 500  shares  of  common  stock  in  payment  of  a 
dividend  declared  from  a  surplus  amounting  to  $50,000. 
The  value  at  which  the  shares  should  be  included  in  the 
return  is  $100  per  share. 

The  practical  effect  of  this  provision  is  to  treat  a 
stock  dividend  as  income  to  the  extent  of  the  par  value 
of  the  stock  received.  The  author  cannot  recollect  any 
case  in  which  stock  was  distributed  as  a  dividend  at 
any  other  figure  than  its  par  value. 


88         INCOME   AND  FEDERAL    TAX    REPORTS 

The  taxing  of  stock  dividends  at  their  full  par  value 
often  results  in  a  double  taxation  and  a  consequent  in- 
justice to  the  last  purchaser  of  the  stock.  To  turn  to 
the  case  of  Bethlehem  Steel  Company:  Bethlehem  Steel 
Common,  (now  class  A,  common)  in  1914  could  be 
bought  at  $40  a  share.  A  person  buying  100  shares  in 
1914  at  40  and  selling  them  in  January,  1917,  at  415, 
would  be  taxed  on  the  profit  of  $37,500.  This  would 
be  no  more  than  fair  as  he  had  actually  made  that 
profit  on  the  transaction.  Turning  to  the  man  who 
bought  the  stock  at  415  in  February,  we  find  that  he 
received  a  200  per  cent  stock  dividend  in  a  new  class  B 
common  stock  on  which  he  would  be  taxed  on  its  par 
value,  $20,000. 

This  taxes  the  holder  on  income  which  his  capital 
never  earned,  as  he  made  no  profit  by  the  receipt  of  the 
dividend.  After  receiving  the  dividend  he  holds  100 
shares  of  class  A  common  and  200  shares  of  class  B 
common,  the  average  market  value  of  which  for  the 
month  of  March,  1917,  was  as  follows: 

100  shares  class  A  at  135  $13,500 

200  shares  class  B  at  125    25,000 

$38,500 
Original  cost  of  100  shares  A  41,500 

Market  Loss $  3,000 

Should  the  holder  of  these  shares  sell  them  subsequently 
for  less  than  $61,500  (i.e.  $41,500  +  $20,000)  he  would 
be  allowed  to  deduct  the  difference  as  a  loss,  subject  to 
the  restrictions  on  losses,  see  chapter  on  Deductions. 

Stock  dividends  held  not  taxable  under  1913  law. — The 
entire  question  of  the  taxability  of  stock  dividends  has 
been  reopened  by  the  decision  of  the  United  States  Su- 
preme Court  in  Toivne  vs.  Eisner,  decided  January  7, 
1918,  which  holds  that  a  stock  dividend  declared  January 


INDIVIDUAL  INCOME   TAX 


89 


2,  1914,  should  not  have  been  regarded  as  income 
under  the  provisions  of  the  law  of  October  3,  1913. 
The  decision,  written  by  Justice  Holmes,  follows: 


Henry  R.  Towne  Plaintiff  in  Error, 
vs. 

Mark  Eisner,  Collector  of  United 
States  Revenue  for  the  Third  Dis- 
trict of  the  State  of  New  York. 


In  error  to  the  District  Court 

of  the  United  States  for  the 

Southern  District  of  New  York. 


Argued   December    12,    1917. 
Decided  January  7,   1918. 
Charles  E.  Hughes 
George   Welwood   Murray 
Charles  P.  Howland 
Louis   H.  Porter, 

Counsel  for  Plaintiff  in  Error. 
John  W.  Davis,  Solicitor  General 

Counsel  for  the  United  States. 

Mr.  Justice  Holmes  delivered  the  opinion  of  the  Court. 

This  is  a  suit  to  recover  the  amount  of  a  tax  paid  under  duress 
in  respect  of  a  stock  dividend  alleged  by  the  Government  to  be  income. 
A  demurrer  to  the  declaration  was  sustained  by  the  District  Court  and 
judgment  was  entered  for  the  defendant.  242  Fed.  Rep.  702.  The  facts 
alleged  are  that  the  corporation  voted  on  December  17,  1913,  to  transfer 
$1,500,000  surplus,  being  profits  earned  before  January  1,  1913,  to  its 
capital  account,  and  to  issue  fifteen  thousand  shares  of  stock  representing 
the  same  to  its  stockholders  of  record  on  December  26;  that  the  dis- 
tribution took  place  on  January  2,  1914,  and  that  the  plaintiff  received 
as  his  due  proportion  four  thousand  and  one  hundred  and  seventy-four 
and  a  half  shares.  The  defendant  compelled  the  plaintiff  to  pay  an 
income  tax  upon  his  stock  as  equivalent  to  $417,450  income  in  cash. 
The  District  Court  held  that  the  stock  was  income  within  the  meaning 
of  the  Income  Tax  Act  of  October  3,  1913,  c.  16,  Section  II;  A,  sub- 
division 1  and  2;  and  B.  38  Stat.  114,  166,  167.  It  also  held  that  the 
Act  so  constructed  was  constitutional,  whereas  the  declaration  set  up 
that  so  far  as  the  Act  purported  to  confer  power  to  make  this  levy 
it  was  unconstitutional  and  void. 

The  Government  in  the  first  place  moved  to  dismiss  the  case  for 
want  of  jurisdiction,  on  the  ground  that  the  only  question  here  is  the 
construction  of  the  statute,  not  its  constitutionality.  It  argues  that 
if  such  a  stock  dividend  is  not  income  within  the  meaning  of  the  con- 
stitution, it  is  not  income  within  the  intent  of  the  statute,  and  hence 
that  the  meaning  of  the  Sixteenth  amendment  is  not  an  immediate  issue, 
and  is  important  only  as  throwing  light  on  the  construction  of  the 
Act.  But  it  is  not  necessarily  true  that  income  means  the  same  thing 
in  the  Constitution  and  the  Act.     A  word  is  not  a  crystal,  transparent 


90  INCOME    AND  FEDERAL    TAX    REPORTS 

and  unchanged;  it  is  the  skin  of  a  living  thought  and  may  vary  greatly 
in  color  and  content  according  to  the  circumstances  and  the  time  in 
which  it  is  used.  Lamar  vs.  United  States,  240  U.  S.  60,  65.  Whatever 
the  meaning  of  the  Constitution,  the  Government  had  applied  its  force  to 
the  plaintiff,  on  the  assertion  that  the  statute  authorized  it  to  do  so,  be- 
fore the  suit  was  brought,  and  the  Court  below  has  sanctioned  its  course. 
The  plaintiff  says  that  the  statute  as  it  is  construed  and  administered 
is  unconstitutional.  He  is  not  to  be  defeated  by  the  reply  that  the  Gov- 
ernment does  not  adhere  to  the  construction  by  virtue  of  which  alone 
it  has  taken  and  keeps  the  plaintiff's  money,  if  this  Court  should  think 
that  the  construction  would  make  the  Act  unconstitutional.  While  it 
keeps  the  money  it  opens  the  question  whether  the  Act  construed  as  it 
has  construed  it  can  be  maintained.  The  motion  to  dismiss  is  overruled. 
Billings  vs.  United  States,  232  U.  S.  261,  267.  B.  Altman-Company  vs. 
United  States,  224  U.  S.  583,  596,  597. 

The  case  being  properly  here,  however,  the  construction  of  the  Act  is 
open,  as  well  as  its  constitutionality  if  construed  as  the  Government  has 
construed  it  by  its  conduct.  Billings  vs.  United  States  ubi  supra.  Not- 
withstanding the  thoughtful  discussion  that  the  case  received  below  we 
can  not  doubt  that  the  dividend  was  capital  as  well  for  the  purposes  of 
the  Income  Tax  Law  as  for  distribution  between  tenant  for  life  and 
remainderman.  What  was  said  by  this  Court  upon  the  latter  question  is 
equally  true  for  the  former.  "A  stock  dividend  really  takes  nothing 
from  the  property  of  the  corporation,  and  adds  nothing  to  the  interest 
of  the  shareholders.  Its  property  is  not  diminished  and  their  interests 
are  not  increased.  .  .  .  The  proportional  interest  of  each  shareholder 
remains  the  same.  The  only  change  is  in  the  evidence  which  represents 
that  interest,  the  new  shares  and  the  original  shares  together  represent- 
ing the  same  proportional  interest  that  the  original  shares  represented 
before  the  issue  of  the  new  ones."  Gibbons  vs.  Mahon,  136  U.  S.  549, 
559,  560.  In  short,  the  corporation  is  no  poorer  and  the  stockholder  is 
no  richer  than  they  were  before.  Logan  County  vs.  United  States,  169 
U.  S.  255,  261.  If  the  plaintiff  gained  any  small  advantage  by  the  change 
it  certainly  was  not  an  advantage  of  $417,450,  the  sum  upon  which  he 
was  taxed.  It  is  alleged  and  admitted  that  he  received  no  more  in  the 
way  of  dividends  and  that  his  old  and  new  certificates  together  are 
worth  only  what  the  old  ones  were  worth  before.  If  the  sum  had  been 
carried  from  surplus  to  capital  account  without  a  corresponding  issue  of 
stock  certificates,  which  there  was  nothing  in  the  nature  of  things  to 
prevent,  we  do  not  suppose  that  any  one  would  contend  that  the  plaintiff 
had  received  an  accession  to  his  income.  Presumably  his  certificate  would 
have  the  same  value  as  before.  Again  if  certificates  for  $1,000  par  were 
split  up  in  ten  certificates,  each  for  $100,  we  presume  that  no  one  would 
call  the  new  certificates  income.  What  has  happened  is  that  the  plaintiff's 
old  certificates  have  been  split  up  in  effect  and  have  diminished  in  value 
to  the  extent  of  the  value  of  the  new. 

Judgment  reversed. 

Mr.  Justice  McKenna  concurs  in  the  resujt. 


INDIVIDUAL  INCOME  TAX  91 

Effect  of  "Towne  vs.  Eisner"  decision  on  stock  dividends 
paid  in  1913,  1914  and  1915. — The  court  in  Towne  vs. 
Eisner,  decided  that  under  the  provisions  of  the  In- 
come Tax  law  of  October  3,  1913,  stock  dividends  could 
not  be  taxed  as  income.  All  taxes  collected  on  such 
dividends  in  1913,  1914  and  1915  were  wrongfully  as- 
sessed and  collected.  All  persons  who  paid  an  income 
tax  on  stock  dividends  in  1913,  1914  and  1915  are  no 
doubt  entitled  to  a  refund  and  should  file  a  claim  for 
the  same  with  the  collector  for  the  district  in  which 
the  return,  on  which  the  tax  was  wrongfully  assessed, 
was  filed.1 

Treasury  Department  holds  stock  dividends  taxable  un- 
der the  1916  and  1917  laws. — The  only  Income  Tax  law 
considered  by  the  court  was  the  October  3,  1913,  law. 
But  the  wording  of  the  decision  is  such  that  it  may  be 
inferred  that  the  taxing  of  stock  dividends  is  unconsti- 
tutional. Inasmuch  as  this  part  of  the  opinion  was 
not  necessary  to  the  decision  it  is  merely  dictum  and 
its  weight  is  questionable. 

The  Treasury  Department  maintains  that  the  decis- 
ion does  not  change  the  right  to  tax  stock  dividends 
paid  in  1916  and  1917.  The  basis  of  their  argument  is 
that  the  law  of  September  8,  1916,  contains  a  provision 
(section  31,  a)  which  specifically  taxes  stock  dividends. 
This  position  of  the  department  is  shown  in  the  follow- 
ing letter: 

"Treasury  Department, 
"Office  of  Commissioner  of  Internal  Revenue, 
"Washington,  D.  C,  January  10,  1918. 
"To  Collectors  of  Internal  Revenue, 

and  Internal  Revenue  Agents: 

"Please  note  carefully  the  statement  below  with  reference  to  the  effect 
of  the  decision  of  the  Supreme  Court  of  January  7,  1918,  in  the  case 
of  Towne  vs.  Eisner  and  see  that  it  is  given  general  publicity. 

"Daniel  C.  Roper, 

"Commissioner. 

i  As  yet  the  Treasury  Department  has  issued  no  statement  as  to 
whether  this  particular  case  will  apply  to  tax  imposed  upon  stock  divi- 
dends paid  in  1913,  1914  or  1915  from  profits  earned  by  the  corporation 
subsequent  to  March   1,  1913. 


92  INCOME    AND    FEDERAL    TAX    REPORTS 

"Misapprehension  exists  as  to  the  effect  of  the  decision  of  the  Supreme 
Court  in  the  case  of  Towne  vs.  Eisner,  handed  down  January  7,  1918. 
In  this  opinion  it  was  held  that  under  the  Act  of  October  3,  1913,  a  stock 
dividend  declared  by  a  corporation  January  2,  1914,  was  not  properly 
regarded  as  income.  It  does  not  necessarily  follow,  however,  that  no 
stock  dividends  are  to  be  held  taxable  under  the  provisions  of  the  Acts 
of  September  8,  1916,  and  October  3,  1917. 

"The  Act  of  October  3,  1913,  which  was  the  only  Act  before  the  Court 
in  the  case,  contained  no  provision  expressly  providing  for  treating  stock 
dividends  as  income,  and  the  decision  of  the  Court  was  to  the  effect  that 
the  Act  was  not  to  be  construed  as  taxing  such  dividends.  The  Court 
did  not  decide  that  such  dividends  cannot  be  income  within  the  meaning 
of  the  Sixteenth  Amendment,  but  expressly  recognized  that  the  word 
"income"  may  have  a  different  meaning  in  the  Statute  from  the  meaning 
in  the  Constitution. 

"The  Act  of  September  8,  1916,  contains  an  express  provision  taxing 
stock  dividends  declared  and  paid  out  of  earnings  accrued  since  March 
1,  1913.  In  the  absence  of  a  decision  as  to  the  legal  effect  of  these  ex- 
press provisions  contained  in  the  latter  Acts,  the  Bureau  of  Internal 
Revenue  naturally  will  continue  to  be  governed  by  the  express  provisions 
of  the  later  Acts  in  reference  to  stock  dividends." 

Opinions  opposed  to  Treasury  Department's  holding. — 
While  the  holding  of  the  Department,  it  seems,  is  tech- 
nically correct,  the  weight  of  the  opinion  outside  of  the 
Department  is  that  the  decision  affects  all  the  income 
tax  laws  and  that  the  Supreme  Court  will  so  decide  if  a 
test  case  is  brought  before  it. 

The  arguments  supporting  this  position  are  brought 
out  in  the  following  editorial  from  the  New  York  Times. 

"Trifling  With  the  Court"  ■ 
"The  Commissioner  of  Internal  Revenue  says  that 
income  taxes  will  be  collected  upon  stock  dividends,  the 
opinion  of  the  Supreme  Court  under  the  law  of  1913 
to  the  contrary  notwithstanding.  The  Collector  relies 
upon  the  declaration  of  the  law  of  1916  that 

"  'Dividends  shall  be  held  to  mean  any  distribution 
made  or  ordered  to  be  made  .  .  .  payable  to  share- 
holders, whether  in  cash  or  stock  .  .  .  which  said  stock 
dividend  shall  be  considered  income  to  the  amount  of 
the  earnings  or  profits  so  distributed.* 

i  New  York  Times,  January  12,  1918. 


INDIVIDUAL  INCOME   TAX  93 

"No  doubt  Congress  can  tax  either  property  or  in- 
come, but  it  cannot  tax  both  by  simply  declaring  that 
one  is  the  other,  when  the  Supreme  Court  says  that 
they  are  different.  It  is  true  that  the  court's  decision 
arose  under  the  statute  of  1913,  which  contains  no  such 
provision  as  the  one  quoted  above.  But  the  court's 
decision  was  on  principle,  not  on  the  words  of  the 
statute,  and  the  principle  is  applicable  to  both  statutes. 
The  court  decided  that  income  must  be  something  which 
is  separated  from  the  principal,  as  crops  are  severed 
from  land,  or  dividends  paid  in  cash  are  separated  from 
the  resources  of  the  company.  A  share  dividend  sepa- 
rates nothing  from  the  property  of  the  corporation. 
In  the  words  of  the  court: 

"  'A  stock  dividend  really  takes  nothing  from  the 
property  of  the  corporation,  and  adds  nothing  to  the 
interest  of  the  shareholders.  Its  property  is  not  dimin- 
ished and  their  interests  are  not  increased.  .  .  .  The 
proportional  interest  of  each  shareholder  remains  the 
same.  The  only  change  is  in  the  evidence  which  repre- 
sents the  interest,  the  new  shares  and  the  old  shares 
together  representing  the  same  proportional  interest 
that  the  original  shares  represented  before  the  issue  of 
the  new  ones.' 

"The  definition  of  the  later  law  may  suffice  to  control 
the  discretion  of  the  tax  collectors,  but  it  will  not  per- 
suade the  court  that  income  is  principal,  or  that  prin- 
cipal is  income,  because  they  are  so  defined  by  a  statute. 
If  either  can  be  taxed  under  the  name  of  the  other, 
then  it  can  be  taxed  under  both  names,  with  the  result 
of  double  taxation  and  deprivation  of  property  without 
due  process  of  law.  The  statute  will  signify  as  little  to 
the  court  as  the  court's  decision  signifies  to  the  tax 
authorities.  If  anything  is  collected  under  this  defini- 
tion, it  will  be  repaid,  unless  the  court  shall  change  its 
mind  regarding  the  constitutional  argument.    The  lower 


94  INCOME   AND  FEDERAL    TAX    REPORTS 

court  decided  that  stock  dividends  were  taxable  as  in- 
come under  the  1913  statute,  and  the  Supreme  Court 
overruled  it.  The  lower  court  also  decided  that  the 
1913  statute  was  constitutional  with  that  construction 
regarding  the  taxability  of  stock  dividends  as  income. 
Before  the  Supreme  Court  the  Government  would  have 
abandoned  the  argument  for  the  constitutionality  of  the 
1913  statute  as  thus  construed,  but  was  not  allowed  to 
do  so.  The  Supreme  Court  said  that  while  the  Treas- 
ury kept  the  tax  money  it  was  to  be  held  to  the  position 
it  took  originally  as  to  the  constitutionality  of  the  stat- 
ute as  thus  construed. 

"When  the  tax  officers  go  into  the  Supreme  Court  with 
the  1916  statute  they  are  sure  to  be  met  with  the  argu- 
ment of  Mr.  Hughes,  supported  by  the  decision  which 
already  is  against  them.  The  statute  upon  which  they 
rely  is  to  blame,  not  the  tax  collectors.  Least  of  all  are 
the  taxpayers  to  blame  for  disputing  the  statute.  The 
statute  is  obnoxious  to  most  of  the  canons  of  taxation. 
In  the  instant  case  the  attempt  was  to  collect  a  tax  upon 
$417,450,  which  the  court  said  Mr.  Towne  did  not  re- 
ceive. His  dividends  were  not  increased,  his  property 
was  not  increased,  and  yet  he  was  to  be  taxed  upon  a 
half  million  of  printed  paper.  There  is  $100,000,000  of 
such  paper  now  claimed  to  be  taxable,  although  the  tax 
is  brand  new.  The  result  of  maintaining  the  constitu- 
tionality of  the  statute  would  be  to  overturn  settled 
principles  of  law  and  finance." 

This  attitude  is  substantially  the  same  as  that  taken 
by  Archibald  E.  "Watson,  former  Corporation  Counsel 
of  New  York,  in  an  interview  reprinted  below. 

"Sees    Stock    Dividend    Free    From    Taxation"  1 

"Archibald  E.  Watson,  former  Corporation  Counsel, 
a  member  of  the  law  firm  of  Barber,  Watson  &  Gib- 
boney,  said  yesterday  that  the  recent  income  tax  decis- 

iNew  York  Times,  January  13,  1918. 


INDIVIDUAL  INCOME  TAX  95 

ion  of  the  United  States  Supreme  Court  in  the  case  of 
Towne  vs.  Eisner  would  precede  in  authority  any  order 
of  any  Federal  department.  Mr.  Watson  was  asked  to 
comment  on  the  decision  and  on  the  bulletin  of  the 
Treasury  Department  instructing  Internal  Revenue  Col- 
lectors to  continue  to  assess  and  collect  income  taxes 
upon  stock  dividends,  because  his  firm,  as  amicus  curiae, 
submitted  a  brief  when  the  case  was  in  the  Federal  Dis- 
trict Court. 

"Mr.  Watson  said  that  the  Commissioner  of  Internal 
Revenue  apparently  regarded  the  Supreme  Court  de- 
cision as  inconclusive.  He  based  this  statement  on  the 
instructions  to  Collectors  of  Internal  Revenue  to  treat  as 
income  all  stock  dividends  declared  and  paid  out  of 
earnings  accrued  since  March  1,  1913. 

"Collector  Edwards,  in  a  recent  statement,  called  at- 
tention to  the  opinion  of  the  United  States  Supreme 
Court  that  a  stock  dividend  declared  by  a  corporation 
Jan.  2,  1914,  under  the  act  of  Oct.  3,  1913,  was  not 
properly  regarded  as  income.  He  thought,  however, 
that  it  did  not  necessarily  follow  that  no  stock  dividends 
were  to  be  held  taxable  under  the  provisions  of  the 
acts  of  Sept.  8,  1916,  and  Oct.  3,  1917.  He  recalled  that 
the  act  of  1913  was  the  only  one  before  the  court,  and 
that  it  contained  no  provisions  expressly  providing  for 
treating  stock  dividends  as  income." 

Opinion  of  the  Court 

"Mr.  Watson  declared  that  the  opinion  of  the  Su- 
preme Court  was  both  a  'decision  upon  particular  facts 
and  an  enunciation  of  principles,'  and  that  a  fair  deduc- 
tion of  the  language  of  the  court  was  'that  a  stock  divi- 
dend based  upon  earnings'  was  not  taxable. 

"  'The  first  income  tax  law,'  said  Mr.  Watson,  'which 
was  passed  Oct.  3,  1913,  was  made  retroactive  to  March 
1st  of  that  year,  the  constitutional  amendment  authoriz- 
ing a  direct  tax  on  incomes  not  having  become  effective 


96  INCOME    AND  FEDERAL    TAX    REPORTS 

until  Feb.  28,  1913.  Of  course,  the  decision  of  the 
United  States  Supreme  Court  is  conclusive  and  final  as 
to  everything  actually  decided  or  necessarily  involved 
in  the  decision. 

"  'The  bulletin  issued  by  the  Treasury  Department 
claims  that  in  the  case  of  Towne  vs.  Eisner  the  Su- 
preme Court  only  held  that  under  the  law  of  Oct.  3, 
1913,  a  stock  dividend  declared  in  January,  1914,  was 
not  properly  regarded  as  income.  But  Towne  vs.  Eis- 
ner was  both  a  decision  upon  particular  facts  and  an 
enunciation  of  principles.  Limited  to  its  special  cir- 
cumstances, it  is  not  of  wide  interest,  because  of  the 
comparatively  few  persons  in  like  situation.  But  as  a 
declaration  of  fundamentals  it  is  sure  to  have  important 
consequences. 

"  'Though  the  case  does  not  expressly  so  hold,  a  fair 
deduction  from  its  language  is  that  a  stock  dividend, 
based  upon  surplus  earnings,  which  have  in  good  faith 
been  carried  into  capital,  is  not  taxable  as  income  under 
the  Sixteenth  Amendment  to  the  Constitution;  that  is 
to  say,  a  further  constitutional  change  would  be  required 
to  authorize  such  u  tax.  In  this  connection  Mr.  Justice 
Holmes  reaffirms  the  doctrine  of  the  Gibbons  case,  de- 
cided in  1890,  (136  U.  S.  549),  which  did  not,  however, 
involve  the  taxation  of  stock  dividends,  quoting  the 
following : 

"  'A  stock  dividend  really  takes  nothing  from  the 
property  of  the  corporation,  and  adds  nothing  to  the 
interest  of  the  shareholders.  Its  property  is  not  dimin- 
ished and  their  interests  are  not  increased.  .  .  .  The 
proportional  interest  of  each  shareholder  remains  the 
same.  The  only  change  is  in  the  evidence  which  rep- 
resents that  interest,  the  new  shares  and  the  original 
shares  together  representing  the  same  proportional  in- 
terest that  the  original  shares  represented  before  the 
issue  of  the  new  ones.' 


INDIVIDUAL    INCOME    TAX  97 

"  'Justice  Holmes'  opinion  concludes  with  the  sen- 
tence : 

"  'What  has  happened  is  that  the  plaintiff's  old  cer- 
tificates have  been  split  up  in  effect  and  have  diminished 
in  value  to  the  extent  of  the  value  of  the  new. 

"  'A  tax  upon  the  certificates,  therefore,  would  be  a 
tax  on  capital  and  not  upon  income,  and  as  such  not  au- 
thorized by  the  Sixteenth  Amendment. 

"  'Under  the  present  income  tax  law,  as  amended, 
stock  dividends  are  declared  to  be  subject  to  tax  as 
income  in  the  hands  of  the  stockholder,  but  only  at  the 
income  tax  rates  in  force  at  the  time  the  profits  so  dis- 
tributed were  earned.  Under  the  reasoning  of  the  opin- 
ion in  the  Towne  vs.  Eisner  case,  however,  such  divi- 
dends would  not  be  taxable  at  all,  because,  in  effect, 
only  a  splitting  up  of  the  stockholder's  old  certificates, 
or  a  change  in  the  evidence  representing  the  stockhold- 
er's interest. 

May  Hypothecate  Stock 

"  'It  may  be  anticipated,  therefore,  that  stock  divi- 
dends in  preference  to  cash  dividends  will  be  more 
popular  than  ever  during  the  coming  year.  The  re- 
cipient of  a  stock  dividend  may  hypothecate  the  stock 
as  security  for  a  loan  without  being  taxed  upon  the 
amount  so  borrowed,  and  would  even  be  allowed  as  a 
deduction  interest  paid  upon  such  a  loan,  under  the 
provisions  of  the  law  as  it  stands: 

"Of  course,  if  the  recipient  of  a  stock  dividend  should 
sell  the  stock  so  received,  together  with  the  original 
stock  held  by  him,  any  profit  thus  realized  over  and 
above  the  original  cost  of  the  stock,  in  respect  of 
which  the  stock  dividend  was  declared,  would  probably 
be  taxed  as  income.  But  short  of  this  there  would  ap- 
pear to  be  considerable  advantage  in  dividend  distribu 
tions  of  stock  in  preference  to  cash  by  corporations. 

"  'It  is  true,  as  pointed  out  in  the  recent  bulletin  of 


98  INCOME   AND    FEDERAL    TAX    REPORTS 

the  Treasury  Department,  the  act  of  October  3,  1913, 
does  not  contain  an  express  provision  for  the  taxing  of 
stock  dividends.  Later  acts,  that  is,  the  act  of  Septem- 
ber 8,  1916,  and  of  October  3,  1917,  do  contain  such 
provisions.  The  act  of  October  3,  1913,  purports,  how- 
ever, to  tax  dividends,  without  distinguishing  between 
cash  dividends  and  dividends  paid  in  stock,  and  the 
Treasury  Department  ruled  that  stock  dividends  con- 
stituted taxable  income  to  the  same  extent  as  cash. 
If  the  Commissioner  of  Internal  Eevenue  is  in  doubt 
about  the  matter,  the  sooner  a  test  case  is  brought  the 
better  for  all  concerned.  But  there  can  be  little  doubt 
that  the  principle  enunciated  by  the  Supreme  Court  in 
the  case  of  Towne  vs.  Eisner  will  be  held  to  prevent 
the  taxation  of  stock  dividends,  whether  under  the  in- 
come tax  law  of  October,  1913,  or  later  enactments.' " 

The  position  of  the  taxpayer. — Until  the  matter  of  the 
taxability  of  stock  dividends  under  the  1916  and  1917 
laws  is  finally  passed  on  by  the  courts,  the  individual 
taxpayer  will  be  compelled  to  conform  with  the  require- 
ments of  the  Treasury  Department. 

Those  taxpayers  who  have  received  in  1917  stock 
dividends  representing  earnings  of  corporations  earned 
subsequent  to  March  1,  1913,  should  include  such 
amounts  in  their  returns  of  income,  and  attach  to  such 
return  of  income  a  statement  fully  setting  forth  the 
facts.  Such  returns  should  be  filed  under  protest,  until 
such  time  as  it  is  seen  what  will  be  the  decision  of  the 
court  with  reference  to  the  acts  of  1916  and  1917.  In 
case  the  position  of  the  Department  is  not  upheld  by  the 
Court,  the  taxpayer  will  then  be  able  to  obtain  a  refund 
of  any  such  taxes  paid  under  protest. 

Income  on  building  and  loan  shares. — It  is  held  that  amount  credited 
to  shareholders  of  building  and  loan  associations,  when  title  to  such  credit 
passes  to  the  shareholder  at  the  time  of  the  credit,  has  a  taxable  status 
for  the  normal  and  additional  tax  as  for  the  year  of  the  credit. 

Where  the  amount  of  such  accumulations  does  not  become  available  to 
the  shareholder  until  the  maturity  of  a  share  the  amount  of  a  share  in 
excess  of  the  aggregate  amount  paid  in  by  the  shareholder  is  income  to 
be  accounted  for  as  for  the  year  of  the  maturity  of  the  share  for  both 
the  normal  and  additional  tax. 


CHAPTER  IV 
INDIVIDUAL  INCOME  TAX 

DEDUCTIONS  FROM  GROSS  INCOME 

Deductions  from  gross  income. — The  income  tax  is 
based  upon  the  net  income  of  the  individual  making 
the  return.  After  computing  his  gross  income  the  in- 
dividual will  calculate  the  deductions  allowed  him  by 
law  and  by  subtracting  these  deductions  from  his  gross 
income  will  arrive  at  his  net  income. 

Deductions  allowed  in  computing  net  income  of  citizens 
and  residents  of  the  United  States, — The  Income  Tax  law? 
sec.  5,  provides,  that  in  computing  net  income  in  the 
case  of  a  citizen  or  resident  of  the  United  States — 

"  ( a )     For  the  purpose  of  the  tax  there  shall  be  allowed  as  deductions : 

"First — The  necessary  expenses  actually  paid  in  carrying  on  any  busi- 
ness, or  trade,  not  including  personal,  living  or  family  expenses. 

"Second — All  interest  paid  within  the  year  on  his  indebtedness  except 
on  indebtedness  incurred  for  the  purchase  of  obligations  or  securities  the 
interest  upon  which  is  exempt  from  taxation  as  income  under  this  title. 

"Third — Taxes  paid  within  the  year  imposed  by  the  authority  of  the 
United  States  (except  income  and  excess  profits  taxes)  or  of  its  Territories, 
or  possessions,  or  any  foreign  country,  or  by  the  authority  of  any  State, 
county,  school  district,  or  municipality,  or  other  taxing  subdivision  of  any 
State,  not  including  those  assessed  against  local  benefits. 

"Fourth — Losses  actually  sustained  during  the  year,  incurred  in  his 
business  or  trade,  or  arising  from  fires,  storms,  shipwreck,  or  other  cas- 
ualty, and  from  theft,  when  such  losses  are  not  compensated  for  by  insur- 
ance or  otherwise: 

"Provided,  that  for  the  purpose  of  ascertaining  the  loss  sustained  from 
the  sale  or  other  disposition  of  property,  real,  personal,  or  mixed,  acquired 
before  March  first,  nineteen  hundred  and  thirteen,  the  fair  market  price 
or  value  of  such  property  as  of  March  first,  nineteen  hundred  and  thir- 
teen, shall  be  the  basis  for  determining  the  amount  of  such  loss  sustained. 

99 


100  INCOME   AND    FEDERAL    TAX    REPORTS 

"Fifth — In  transactions  entered  into  for  profit  but  not  connected  with  his 
business  or  trade,  the  losses  actually  sustained  therein  during  the  year 
to  an  amount  not  exceeding  the  profits  arising  therefrom. 

"Sixth — Debts  due  to  the  taxpayer  actually  ascertained  to  be  worthless 
and  charged  off  within  the  year. 

"Seventh — A  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of 
property  arising  out  of  its  use  or  employment  in  the  business  or  trade. 

"Eighth — (a)  In  the  case  of  oil  and  gas  wells  a  reasonable  allowance 
for  actual  reduction  in  flow  and  production  to  be  ascertained,  not  by  the 
flush  flow  but  by  the  settled  production  or  regular  flow. 

"(b)  In  the  case  of  mines  a  reasonable  allowance  for  depletion  not  ex- 
ceeding the  market  value  in  the  mine,  of  the  product  mined  and  sold  during 
the  year  for  which  the  return  is  made. 

"Ninth — Contributions  or  gifts  actually  made  within  the  year  to  cor- 
porations or  associations  organized  and  operated  exclusively  for  religious, 
charitable,  scientific,  or  educational  purposes,  or  to  societies  for  the  pre- 
vention of  cruelty  to  children  or  animals,  no  part  of  the  net  income  of 
which  inures  to  the  benefit  of  any  private  stockholder  or  individual,  to  an 
amount  not  in  excess  of  fifteen  per  centum  of  the  taxpayer's  taxable  net 
income  as  computed  without  the  benefit  of  this  paragraph.  Such  contribu- 
tions or  gifts  shall  be  allowable  as  deductions  only  if  verified  under  rules 
and  regulations  prescribed  by  the  Commissioner  of  Internal  Eevenue,  with 
the  approval  of  the  Secretary  of  the  Treasury." 

Deductions  allowed  in  computing  net  income  of  non-resi- 
dent aliens. — As  to  non-resident  aliens  the  law  allows  the 
following  deductions: 

"First — The  necessary  expenses  actually  paid  in  carrying  on  any  business 
or  trade  conducted  by  him  within  the  United  States,  not  including  per- 
sonal, living  or  family  expenses. 

"Second — The  proportion  of  all  interest  paid  within  the  year  by  such 
person  on  his  indebtedness  (except  on  indebtedness  incurred  for  the  pur- 
chase of  obligations  or  securities  the  interest  upon  which  is  exempt  from 
taxation  as  income  under  this  title)  which  the  gross  amount  of  his  income 
for  the  year  derived  from  sources  within  the  United  States  bears  to  the 
gross  amount  of  his  income  for  the  year  derived  from  all  sources  within 
and  without  the  United  States,  but  this  deduction  shall  be  allowed  only  if 
such  person  includes  in  the  return  required  by  section  eight  all  the  infor- 
mation necessary  for  its  calculation. 

"Third — Taxes  paid  within  the  year  imposed  by  the  authority  of  the 
United  States  (except  income  and  excess  profits  taxes),  or  of  its  Territories, 
or  possessions,  or  by  the  authority  of  any  State,  county,  school  district, 
or  municipality,  or  other  taxing  subdivision  of  any  State,  paid  within 
the  United  States,  not  including  those  assessed  against  local  benefits. 

"Fourth — Losses  actually  sustained  during  the  year,  incurred  in  busi- 
ness or  trade  conducted  by  him  within  the  United  States,  and  losses  of 
property  within  the  United  States  arising  from  fires,  storms,  shipwreck, 


INDIVIDUAL    INCOME    TAX-  101 

or  other  casualty,  and  from  theft,  when  such  losses  are  not  compensated  for 
by  insurance  or  otherwise: 

"Provided,  That  for  the  purpose  of  ascertaining  the  amount  of  such  loss 
or  losses  sustained  in  trade,  or  speculative  transactions  not  in  trade,  from 
the  same  or  any  kind  of  property  acquired  before  March  first,  nineteen 
hundred  and  thirteen,  the  fair  market  price  or  value  of  such  property  as 
of  March  first,  nineteen  hundred  and  thirteen,  shall  be  the  basis  for  de- 
termining the  amount  of  such  loss  or  losses  sustained. 

"Fifth. — In  transactions  entered  into  for  profit  but  not  connected  with 
his  business  or  trade,  the  losses  actually  sustained  therein  during  the 
year  to  an  amount  not  exceeding  the  profits  arising  therefrom  in  the 
United  States. 

"Sixth. — Debts  arising  in  the  course  of  business  or  trade  conducted  by 
him  within  the  United  States  due  to  the  taxpayer  actually  ascertained  to 
be  worthless  and  charged  off  within  the  year. 

"Seventh. — A  reasonable  allowance  for  the  exhaustion,  wear  and  tear 
of  property  within  the  United  States  arising  out  of  its  use  or  employ- 
ment in  the  business  or  trade. 

"Eighth. —  (a)  In  the  case  of  oil  and  gas  wells  a  reasonable  allowance 
for  actual  reductions  in  flow  and  production  to  be  ascertained  not  by 
the  flush  flow,  but  by  the  settled  production  or  regular  flow. 

"(b)  In  the  case  of  mines  a  reasonable  allowance  for  depletion  thereof 
not  to  exceed  the  market  value  in  the  mine  of  the  product  thereof  which 
has  been  mined  and  sold  during  the  year  for  which  the  return  and  com- 
putation are  made. 

"Provided,  That  when  the  allowance  authorized  in  caption  "Eight"  (a) 
and  (b)  shall  equal  the  capital  originally  invested,  or  in  case  of  purchase 
made  prior  to  March  first,  nineteen  hundred  and  thirteen,  the  fair  market 
value  as  of  that  date,  no  further  allowance  for  depletion  shall  be  made. 

"No  deduction  shall  be  allowed  for  an  amount  paid  out  for  new  buildings, 
permanent  improvements,  or  betterments,  made  to  increase  the  value  of 
any  property  or  estate. 

"And  no  deduction  shall  be  made  for  any  amount  of  expense  of  restor- 
ing property  or  making  good  the  exhaustion  thereof  for  which  an  allow- 
ance is  or  has  been  made." 

The  deductions  allowed  to  non-resident  aliens  it  is 
seen  are  practically  the  same  as  those  allowed  to  citi- 
zens and  residents  of  the  United  States  with  the  ex- 
ception that  the  deductions  of  non-resident  aliens  are 
limited  to  items  arising  within  the  United  States,  and 
this  is  for  the  reason  that  non-resident  aliens  need 
report  only  such  income  as  arises  from  sources  within 
the  United  States.  Any  special  distinctions  between 
residents  and  non-resident  aliens  are  considered  under 
the  various  headings. 


102  IXOOUB   AND    FEDERAL    TAX   REPORTS 

Necessary  business  expenses  actually  paid  allowed  as  a 
deduction  from  income. — The  taxpayer  may  first  deduct 
from  gross  income  all  items  of  business  expense  that 
have  actually  been  paid  within  the  calendar  year  and 
that  have  been  incurred  in  the  carrying  on  of  an  indi- 
vidual business.  Family  or  living  expense  cannot  be 
deducted. 

If  an  individual  keeps  his  books  on  an  accrual  basis 
in  which  he  charges  expenses  when  they  are  incurred 
(instead  of  when  they  are  paid)  he  may  deduct  the 
business  expenses  that  have  been  incurred  during  the 
year,  instead  of  the  amount  actually  paid  during  the 
year.  But  if  an  individual  reports  his  expenses  as  in- 
curred he  must  also  report  his  income  as  earned. 
Otherwise  his  records  would  come  under  the  heading 
of  "records  which  do  not  clearly  reflect  his  income,"  and 
would  not  be  acceptable  as  a  basis  from  which  to  make 
his  return. 

Expenses  of  a  partnership  should  not  be  included, 
as  they  are  taken  into  consideration  in  arriving  at  the 
figure  "Net  Income  from  Partnership,"  which  net  fig- 
ure is  reported  on  the  income  side  of  the  return.1 

All  expenses  incurred  in  earning  taxable  income  are  de- 
ductible.— Expenses  incurred  in  earning  income  which 
is  exempt  are  not  allowable  deductions.  But  expenses 
incurred  in  the  earnings  of  taxable  income  are  deduc- 
tible. Deductible  expenses  therefore  include  all  amounts 
paid  by  a  farmer  for  labor  in  preparing  his  land  for 
a  crop  and  the  cultivation,  harvesting,  and  marketing 
of  the  crop;  the  cost  of  the  seed  and  fertilizer  used; 
the  amounts  expended  for  labor  in  caring  for  live 
stock;  the  cost  of  the  feed,  the  cost  of  stock  purchased 
for  the  purpose  of  resale  (it  should  be  understood, 
that  if  such  cost  is  claimed  as  a  deduction,  the  entire 
proceeds  received  upon  a  sale  of  the  stock  is  to  be 
returned  as  income) ;  the  amounts  actually  paid  in  mak- 

i  See  pages  71,  74. 


72V DIVIDUAL    INCOME    TAX  103 

ing  repairs  to  farm  buildings  (but  not  to  the  dwelling 
house  of  the  individual) ;  repairs  to  fences,  farm  ma- 
chinery, etc.  The  cost  of  materials  for  immediate  use, 
of  farm  tools  which  are  used  in  the  course  of  a  year, 
and  the  amount  of  rent  paid  for  a  farm  itself  may  also 
be  deducted. 

A  merchant  may  deduct  as  expenses  the  amounts  paid 
for  advertising,  hire  of  clerks  and  other  employees, 
the  cost  of  light,  heat,  water,  telephone,  etc.,  used 
in  or  at  his  place  of  business,  all  freight  bills,  the  cost 
of  operating  delivery  wagons,  trucks  and  the  repairs 
to  the  same. 

If  the  individual  employs  a  minor  son  or  daughter 
to  assist  him  in  his  business  and  to  whom  he  pays  a 
salary  or  wages  for  such  assistance,  such  amount  paid 
is  not  a  proper  deduction  as  an  expense.  If,  however, 
the  son  or  daughter  has  attained  his  or  her  majority 
the  amount  of  compensation  paid  for  such  services 
may  be  claimed. 

Amounts  expended  by  a  business  man  in  entertain- 
ing out-of-town  customers  or  prospective  customers  are 
a  proper  expense,  provided  the  sole  purpose  of  the 
business  man  in  making  such  expenditures  is  to  culti- 
vate the  good  will  of  his  customers  and  secure  an  in- 
crease in  trade.  Such  expenditures  may  be  looked 
upon  in  the  same  light  as  sums  paid  in  advertising 
the  business  or  as  other  selling  expenses. 

The  individual  engaged  in  a  business  and  keeping 
accurate  records  will  have  to  be  able  to  determine  most 
of  the  deductible  expenses  of  his  business.  Some  im- 
portant questions  will  arise  as  to  whether  or  not  cer- 
tain items  are  allowable  as  deductions.  These  questions 
are  taken  up  in  detail  under  Corporation  Deductions, 
in  a  later  chapter.  It  is  the  salaried  or  professional 
man  whose  deductible  expenses  are  fully  treated  here. 

Persona],  family  and  living  expenses  are  not  deductible. 
— Personal,  family  or  living  expenses  are,  by  provision 


104  INCOME    AND    FEDERAL    TAX    REPORTS 

of  the  law,  not  deductible.  Alimony  has  been  definitely 
held  as  a  non-deductible  personal  expense  of  the  person 
paying  it.  All  payments  which  represent  savings  invest- 
ments, such  as  building  and  loan  payments,  pension  fund 
payments,  life  insurance  premiums,  etc.,  are  not  deduc- 
tible. Clothing  as  a  general  rule  is  considered  as  a 
personal  expense.  Actors  and  actresses,  however,  are 
allowed  to  deduct  the  cost  of  stage  costumes  if  of  use 
only  during  the  current  year. 

Wages  paid  domestic  servants,  etc.,  not  deductible. — The 
wages  of  domestic  and  other  servants,  such  as  maids, 
valets  and  chauffeurs  of  pleasure  cars  are  considered 
personal  expenses  and  are  not  deductible. 

Rent  of  living  quarters. — Bent  of  living  quarters  may 
not  be  deducted.  If  an  individual  owns  his  own  home 
he  is  not  required  to  include  in  his  income  the  rental 
value  of  the  property.  On  the  other  hand,  he  is  not 
allowed  to  deduct  the  cost  of  maintenance  of  the  prop- 
erty, other  than  taxes,  and  interest  on  bonds  or  notes 
secured  by  a  mortgage  on  the  property. 

Where  a  building  is  occupied  by  both  a  tenant  and 
the  landlord,  the  expenses  of  maintenance  should  be 
separated  as  between  the  tenant's  and  the  owner's  por- 
tion of  the  building.  The  expenses  applicable  to  the 
tenant's  portion  of  the  building  are  an  allowable  deduc- 
tion. Where  the  expenses  are  not  directly  applicable 
to  either  portion  of  the  building  they  should  be  pro- 
rated on  the  basis  of  the  rental  values  of  the  respec- 
tive portions. 

Where  a  person  uses  his  residence  both  as  a  home 
and  as  an  office,  as  is  very  common  among  physicians 
and  dentists,  he  may  deduct  as  a  necessary  expense  of 
his  business  the  rental  value  of  such  rooms  as  he  uses 
solely  as  an  office,  provided  he  pays  rent. 

Automobiles  used  for  business. — The  cost  of  upkeep 
of  an  automobile  used  for  business  purposes  is  an 
allowable  deduction. 


INDIVIDUAL    INCOME    TAX  105 

This  deduction  is  allowable  even  though  the  machine 
may  be  occasionally  used  for  pleasure.  The  fact  that 
a  physician  occasionally  takes  his  family  out  for  a 
pleasure  trip  does  not  affect  the  fact  that  the  upkeep 
of  the  car  is  a  necessary  expense  of  his  profession. 
But  the  total  upkeep  should  not  be  charged  as  a  busi- 
ness expense.  Only  that  proportion  of  the  expenses 
which  the  business  trip  mileage  bears  to  the  total 
mileage,  including  business  and  pleasure,  should  be 
deducted. 

Membership  dues. — Membership  dues  in  a  club  or 
other  society  are  not  deductible  if  the  organization 
is  for  social  purposes. 

Membership  dues  in  a  trade  or  technical  associa- 
tion, such  as  Trade  Union,  Chambers  of  Commerce, 
Medical  Societies,  etc.,  are  deductible  as  necessary  ex- 
penses. 

Technical  magazines  and  books. — The  same  rule  applies 
to  magazines.  The  cost  of  general  magazines  and  news- 
papers is  considered  as  a  personal  expense.  The  cost 
of  technical  and  trade  magazines  is  a  deductible  ex- 
pense. 

As  to  books,  the  original  cost  of  either  class  of  books 
is  not  a  deductible  expense.  The  depreciation  on  tech- 
nical books  is  an  allowable  deduction  under  the  head- 
ing "depreciation." 

The  premium  on  a  fidelity  bond  is  an  allowable  deduc- 
tion.— If  an  employee  is  required  to  furnish  bond  and 
pay  the  premium  on  such  bond,  as  a  necessary  incident 
of  his  employment,  the  premium  on  the  bond  will 
constitute  an  allowable  deduction  in  computing  net  in- 
come. 

Traveling  expenses. — The  general  rule  is  that  expenses 
incurred  in  traveling  from  place  to  place  in  the  prose- 
cution of  business  may  be  deducted.  A  salesman  work- 
ing on  a  commission  basis  may  deduct  railroad  fares, 
carfare,  etc.    He  may  deduct  the  cost  of  lodging,  but 


106  INCOME    AND    FEDERAL    TAX    REPORTS 

not  the  cost  of  his  meals,  the  distinction  being  that  he 
presumably  maintains  a  home,  and  that  the  cost  of 
lodging  is  an  added  expense  made  necessary  to  earn 
his  income. 

Commutation  to  and  from  work  not  a  deduction. — A 
person  engaged  in  business  in  New  York,  for  exam- 
ple, and  residing  in  the  suburbs  is  not  allowed  to  de- 
duct the  commutation  or  the  fare  to  and  from  his  busi- 
ness.    This  expense  is  a  part  of  the  living  expenses. 

The  landlord's  expenses  in  connection  with  rented  prop- 
erty are  deductible. — Deduction  may  be  claimed  on  ac- 
count of  any  expense  incurred  in  the  maintenance  or 
use  of  property  for  rental  purposes,  including  amounts 
paid  for  repairs,  insurance,  fuel,  light  and  water,  and 
janitor  and  elevator  service.  A  reasonable  allow- 
ance may  also  be  deducted  for  depreciation  of  the 
property.  This  deduction  is  provided  for  under  a  sepa- 
rate heading.1 

Commissions  paid  to  real  estate  agents. — Commissions 
paid  to  real  estate  agents  for  the  collection  of  rents 
and  the  management  of  property  is  a  legitimate  busi- 
ness expense,  and  may  be  deducted.  But  commissions 
paid  for  the  purchase  of  property  are  not  deductible 
expenses.  Such  commissions  should  be  added  to  the 
cost  of  the  property,  and  commissions  paid  for  the  sale 
of  property  should  be  deducted  from  the  selling  price 
in  ascertaining  the  gain  or  loss  on  the  sale. 

Insurance  premiums. — Premiums  paid  for  fire  insur- 
ance on  a  building  which  is  rented  or  leased  to  secure 
an  income  may  be  deducted.  If  the  building  or  property 
is  occupied  by  the  owner  as  a  dwelling,  such  insurance 
charges  are  not  allowable  deductions.2 

Insurance  on  furniture  in  an  individual's  home  is  a 
personal    expense,    but    insurance    on    office    furniture 

i  See  page  122. 

2  If  part  of  the  building  is  rented,  or  is  used  by  the  owner  for  business 
purposes,  apply  the  rules  found  on  page  104. 


INDIVIDUAL    INCOME    TAX  107 

would  be  a  business  expense.  The  cost  of  all  fire, 
burglary,  plate  glass,  sprinkler  leakage  and  other  forms 
of  insurance  on  any  property  used  in  the  business  of 
the  individual  is  a  business  expense.  This  also  includes 
insurance  on  the  live  stock  of  a  farmer,  or  on  a  truck- 
man's horses. 

Life  insurance  premiums  are  not  deductible. — Life  in- 
surance premiums  paid  are  not  an  allowable  deduction. 
The  amount  of  premiums  paid  may,  however,  be  de- 
ductible from  the  proceeds  of  the  policy.1  This  applies 
to  insurance  upon  the  life  of  an  employee,  payable  to 
the  employer,  and  to  insurance  upon  the  life  of  a  part- 
ner payable  to  the  partnership,  as  well  as  insurance 
upon  the  life  of  an  individual. 

Liability  insurance. — Amounts  paid  by  individuals  in 
business  as  insurance  against  a  liability  which  if  ac- 
tually incurred  would  be  deductible  as  an  expense  of 
business,  are  permitted  as  a  deduction. 

Assessments  paid  on  stock  of  a  corporation  are  not  de- 
ductible expenses. — Assessments  paid  by  a  stockholder 
on  stock  he  holds  in  a  corporation  or  other  business 
association  are  not  allowed  as  a  deduction  in  the  indi- 
vidual's return.  Such  assessments  are  considered  an 
investment  of  capital  and  not  an  expense.  This  is  held 
true,  whether  the  assessment  is  legally  levied  by  the 
corporation  or  is  simply  a  voluntary  payment  of  the 
stockholders  to  make  good  a  deficit.  The  amount  of 
the  assessment  may  be  added  to  the  cost  of  the  stock  in 
determining  the  profit  or  loss  from  its  sale. 

Deductions  from  income  allowed  to  farmers. — The 
farmer  may  deduct  from  gross  income  the  legitimate 
expenses  incident  to  the  production  of  farm  products. 
Deduction   may  be   claimed   in   the   return   of   income 

1  The  rulings  of  the  Department  up  to  September,  1916,  permitted  the 
deduction  of  insurance  upon  the  lives  of  employees,  payable  to  employers, 
and  upon  the  lives  of  partners,  payable  to  the  partnership.  Premiums 
which  were  deducted  as  an  expense  of  business  under  these  rulings  may 
not  be  deducted  again  from  the  proceeds  of  policy. 


108  INCOME    AND    FEDERAL    TAX    REPORTS 

for  the  tax  year  in  which  the  right  to  such  deductions 
arises,  although  the  products  to  which  such  expenses 
are  incident  may  not  have  been  sold  or  exchanged  for 
money,  or  a  money  equivalent,  during  the  year  for 
which  the  return  is  rendered.  However,  when  farm 
products  are  held  for  favorable  market  prices,  no  de- 
duction on  account  of  shrinkage  in  weight  or  physical 
value,  or  losses  by  reason  of  such  shrinkage  or  deteri- 
oration in  storage  is  allowed,  as  the  reduction  in  value 
is  reflected  in  the  sales  price  received. 

The  cost  of  live-stock  purchased  for  resale  is  an  al- 
lowable deduction  under  the  item  of  expense,  but 
money  expended  for  stock  for  breeding  purposes  is  re- 
garded as  capital  invested,  and  the  amounts  so  ex- 
pended do  not  constitute  allowable  deductions  except 
where  stock  after  being  purchased  dies  from  disease  or 
injury  or  is  condemned  by  the  public  authorities.  In 
such  a  case  the  farmer  may  deduct  as  an  expense  the 
actual  purchase  price  of  such  stock,  less  any  depre- 
ciation which  he  may  have  previously  claimed,  or  less 
any  insurance  which  he  may  have  collected.1 

Loss  not  to  be  deducted  if  farm  is  for  pleasure. — A  per- 
son cultivating  or  operating  a  farm  for  recreation  or 
pleasure,  on  a  basis  other  than  the  recognized  principles 
of  commercial  farming,  the  result  of  which  operations 
is  a  continual  loss  from  year  to  year,  is  not  regarded 
as  a  farmer.  In  such  cases,  if  the  expenses  incurred 
in  connection  with  the  farm  are  in  excess  of  the  re- 
ceipts therefrom  the  entire  receipts  from  sale  of  prod- 
ucts may  be  ignored  in  rendering  a  return  of  income; 
and  the  expenses  incurred  being  regarded  as  personal 
expenses  will  not  constitute  allowable  deductions  in  the 
return  of  income  derived  from  other  sources.2 

i  The  farmer  is  allowed,  as  an  expense  of  business,  the  premium  so  paid 
for  insurance. 

2  However,  if  the  farm  is  operated  at  a  profit  and  not  a  loss,  the  entire 
receipts  should  be  included  as  income,  and  the  expense  of  such  farm  would 
constitute  a  proper  deduction. 


INDIVIDUAL    INCOME    TAX  109 

Interest. — Under  this  caption  should  be  included  all 
interest  paid  (or  accrued,  if  books  are  kept  on  the  ac- 
crual basis),  during  the  year  on  any  indebtedness,  ex- 
cept that  incurred  in  the  purchase  of  securities  the  in- 
terest on  which  is  exempt  from  the  income  tax. 

The  interest  on  bonds  of  the  second  Liberty  Loan, 
which  includes  both  the  first  conversion  4s,  and  the 
second  4s,  is  exempt  from  the  surtax  only  to  the  ex- 
tent of  the  interest  on  $5,000  par  value  of  the  bonds. 
The  interest  on  indebtedness  incurred  in  the  purchase 
of  second  Liberty  Loan  Bonds  should  not  be  deducted 
under  this  section,  but  it  is  deductible x  in  computing 
the  super-tax.  (T.  D.  2541.)  The  interest  will  also 
be  an  allowable  deduction  in  computing  the  income  sub- 
ject to  the  Excess  Profits  tax.  It  will  be  noticed  that 
an  individual  holding  an  amount  up  to  $5,000  of  second 
Liberty  Loan  Bonds  will  be  allowed  as  deductions  in 
computing  the  surtax  and  Excess  Profits  tax  the  inter- 
est on  the  bonds  and  interest  on  loans  made  to  purchase 
them. 

Interest  paid  to  purchase  stock  of  corporations  which 
pay  dividends  may  be  allowed  as  an  item  of  expense 
in  the  individual's  report,  although  the  dividends  them- 
selves are  not  subject  to  normal  tax  in  the  hands  of 
the  individual,  they  only  bearing  super-tax.  However, 
the  corporation  before  distributing  dividends  is  as- 
sessed a  normal  tax  upon  its  net  income,  and  from  the 
balance  the  dividends  are  paid,  and  it  therefore  follows 
that  the  interest  paid  by  an  individual  on  indebtedness 
incurred  to  purchase  stock  of  a  corporation  is  a  proper 
deduction  in  his  income  tax  report. 

The  amount  of  interest  that  may  be  deducted  by  a 
non-resident  alien  is  limited  by  Sec.  6,  subdivision  2,  of 
the  Income  Tax  law  to:  "The  proportion  of  all  interest 
paid  within  the  year  by  such  person  on  his  indebted- 
ness  which  the  gross   amount   of  his   income   for   the 

i  See  Rate  of  Tax — Deductions  from  Super-Tax. 


HO  INCOME    AND    FEDERAL    TAX    REPORTS 

year  derived  from  sources  within  the  United  States 
bears  to  the  gross  amount  of  his  income  for  the  year 
derived  from  all  sources  within  and  without  the  United 
States,  but  this  deduction  shall  be  allowed  only  if  such 
person  includes  in  the  return  all  the  information  neces- 
sary for  its  calculation." 

For  example,  a  non-resident  alien  has  a  total  income 
of  $100,000,  $10,000  of  which  is  from  sources  within 
the  United  States,  and  he  pays  out  $1,000  in  in- 
terest. He  will  be  allowed  as  a  deduction  1/10  (j^^) 
of  $1,000,  or  $100.  He  will  be  allowed  this  deduction 
only  if  he  includes  in  his  return  a  statement  of  his  total 
income  from  all  sources  and  also  the  total  amount  of 
interest  paid. 

Taxes. — The  individual  may  deduct  all  taxes  paid 
with  the  exception  of  income  and  excess  profits  taxes  lev- 
ied by  the  United  States  and  assessments  levied  for  local 
benefits.  Assessments  levied  for  local  benefits  are  held 
to  include  all  taxes  paid  pursuant  to  assessments  levied 
by  special  districts,  such  as  irrigation,  reclamation, 
drainage  districts,  etc.,  for  sidewalks  in  cities,  street 
extension,  grading,  paving,  etc. 

While  the  individual  may  not  deduct  as  an  expense 
any  excess  profits  taxes  paid,  his  net  income  as  re- 
ported to  the  Government  will  be  credited  with  the 
amount  of  any  excess  profits  tax  imposed  by  act  of 
Congress  and  assessed  for  the  same  calendar  year  or 
fiscal  year  upon  the  taxpayer.  In  the  case  of  a  part- 
nership, each  member  will  be  credited  with  his  propor- 
tionate share  of  the  excess  profits  tax  imposed  upon  the 
partnership. 

The  reason  for  this  distinction  between  deduction  and 
credit  is  clear.  The  excess  profits  tax  is  based  upon  the 
net  income  and  therefore  cannot  be  deducted  in  comput- 
ing the  net  income.  The  law  does  not  intend  a  double 
taxation  and  accordingly  allows  a  credit  for  the  amount 
of  excess  profits  tax  in  imposing  the  Income  Tax. 


INDIVIDUAL    INCOME    TAX  HI 

It  is  to  be  noted  that  the  act  of  September  8,  1916, 
as  amended  October  3,  1917,  distinctly  specified  that  in- 
come taxes  are  not  to  be  included  as  a  deduction.  That 
means  that  as  the  amendments  are  retroactive  to  Janu- 
ary 1,  1917,  but  to  that  date  only,  that  income  taxes 
actually  paid  during  1917  for  the  earnings  of  1916  are 
not  to  be  deducted  in  the  return  of  income  for  1917. 
The  amendment  in  question  applies  only  to  the  business 
man  or  individual  who  keeps  his  books  of  accounts  on 
the  cash  receipt  basis. 

Section  8,  subdivision  (g)  of  the  act  of  September  8, 
1916,  allows  for  the  rendering  of  reports  by  an  in- 
dividual on  a  basis  other  than  "cash"  unless  such 
basis  does  not  truly  reflect  the  true  earnings  for 
the  taxable  period.  Therefore  it  follows  that  those 
individuals  who  kept  their  books  of  accounts  on  the 
"accrual"  basis  for  the  year  1916  and  included  as 
part  of  the  taxes  due,  the  1916  income  tax,  although  it 
was  not  paid  until  later  in  1917,  were  allowed  as  a  de- 
duction the  income  taxes  for  the  year  1916  paid  during 
1917. 

Of  course  this  does  not  apply  to  1917  or  subsequent 
income  taxes. 

Inheritance  tax  not  deductible. — Inheritance  taxes  are 
charges  against  the  corpus  or  capital  of  the  estate  and 
are  not  deductible  either  by  the  estate  or  by  a  bene- 
ficiary. 

This  applies  to  State  inheritance  taxes  as  well  as  to 
the  Federal  Estate  Tax. 

Taxes  on  property  used  as  a  residence  may  be  deducted. — 
The  fact  that  the  property  on  which  the  tax  is  assessed 
is  used  as  a  residence  does  not  prevent  the  deduction  of 
the  tax.  In  this  respect  the  man  who  owns  his  home 
has  an  advantage  over  the  one  who  pays  rent.  The 
owner  is  not  required  to  report  as  income  the  rented 
value  of  the  property,  yet  he  may  deduct  as  ex- 
penses the  taxes  paid  on  such  property  and  any  interest 


112  INCOME    AND    FEDERAL    TAX   REPORTS 

paid  on  mortgages  outstanding  against  the  value  of  the 
property. 

The  rent  payer,  on  the  other  hand,  cannot  deduct 
as  an  expense  the  rent  paid  for  the  residence  he 
occupies. 

Taxes  paid  by  bank  on  stock  held  by  individual. — Taxes 
assessed  against  the  stockholders  of  a  bank  and  paid  by 
the  bank  in  behalf  of  the  stockholders  do  not  constitute 
an  allowable  deduction  from  the  gross  income  of  the 
bank,  but  do  constitute  an  allowable  deduction  as  taxes 
paid  in  the  return  of  the  individual.  Of  course  the  in- 
dividual must  also  report  as  income  from  dividends  the 
amount  of  the  taxes  paid  by  the  bank  in  his  behalf.  If 
the  stock  is  owned  by  one  stockholder  at  the  time  the 
tax  is  levied  and  by  another  at  the  time  it  is  paid  de- 
duction may  be  made  by  the  holder  of  the  stock  at  the 
time  that  the  taxes  were  paid. 

To  illustrate,  A  owns  a  number  of  shares  of  stock 
which  he  holds  at  the  time  the  taxes  are  assessed  against 
the  stockholders  of  a  bank.  A  sells  to  B  prior  to  the 
payment  of  the  tax  by  the  bank.  B,  holding  the  stock 
at  the  time  the  taxes  were  paid  by  the  bank,  would  be 
allowed  the  deduction.  However,  taxes  assessed  while 
the  stock  was  in  A's  hand,  which  became  due  and  pay- 
able prior  to  date  of  sale  to  B,  may  be  deducted  by  A. 

As  has  been  already  pointed  out,  taxes  paid  by  a  bank 
for  the  stockholder  should  be  considered  an  additional 
dividend  by  the  stockholder,  and  included  in  the  return 
of  income  of  the  one  allowed  the  deduction. 

Customs  duties  may  be  deducted. — Customs  duties  paid 
during  the  year  are  allowable  if  they  are  paid  on  mer- 
chandise imported  for  business  purposes.  The  duty 
would  then  be  considered  part  of  the  cost  price  of  the 
merchandise.  If,  however,  the  duty  was  paid  on  per- 
sonal belongings  or  merchandise  to  be  used  for  purposes 
other  than  for  business,  such  duty  would  be  allowed  as 
a  deduction,  because  it  is  an  item  of  taxes. 


INDIVIDUAL    INCOME    TAX  113 

Contributions  to  charitable  organizations. — Contributions 
to  charitable  and  other  similar  organizations  may  be 
deducted  only  to  the  extent  of  15  per  cent  of  the  tax- 
able net  income  of  an  individual  as  computed  without 
deducting  the  amount  of  such  gifts.  An  individual 
having  a  net  income  of  $100,000  could  deduct  such  gifts 
or  contributions  to  the  extent  of  $15,000.  This  provis- 
ion is  a  new  feature  in  the  law;  the  1916  act  as  origi- 
nally enacted  specifically  stated  that  gifts  of  any  sort 
were  not  deductible.  The  change  is  undoubtedly  due 
to  the  enormous  amounts  contributed  to  the  Red  Cross 
and  other  war  charitable  organizations.  Deductible  con- 
tributions include  contributions  made  to  the  Red  Cross, 
Y.  M.  C.  A.,  Knights  of  Columbus  War  Fund,  for  the 
furtherance  of  any  religious  activities,  including  the 
construction  of  a  new  church,  and  to  the  associated 
charities  of  one's  home  city.  Contributions  made  to- 
ward the  support  of  a  needy  family  cannot  be  included, 
as  contributions  made  to  individuals  do  not  constitute 
allowable  deductions,  which  deductions  are  limited  to 
contributions  made  to  organizations  or  associations. 
Of  course,  the  association  need  not  be  a  duly  incorpo- 
rated organization. 

A  non-resident  alien  is  not  allowed  to  deduct  gifts 
or  contributions  made  to  charitable  organizations,  etc., 
neither  are  any  corporations  either  domestic  or  foreign. 

BUSINESS  LOSSES 

Necessity  for  distinguishing  "business"  losses. — Under  the 
Income  Tax  law,  as  in  effect  for  the  years  1913  to  1915, 
inclusive,  no  deductions  were  allowed  except  for  losses 
incurred  in  business,  but  all  profits  from  sources  outside 
the  business  were  included  as  income.  As  amended  in 
1916,  the  law  permits  the  deduction  of  losses  outside  of 
business  but  this  deduction  is  limited  to  the  amount  of 
profits  derived  from  similar  sources  during  the  year. 
It  is  therefore  important  to  know  just  what  the  Treasury 


114  INCOME    AND    FEDERAL    TAX    REPORTS 

Department's  definition  of  business  is,  and  what  losses 
it  will  consider  as  "losses  incurred  in  business  or  trade." 
Definition  of  "business"  and  "trade." — Business  has  been 
defined  by  the  Treasury  Department  as  "That  which  oc- 
cupies and  engages  the  time,  attention  and  labor  of  any 
one  for  the  purpose  of  livelihood,  profit,  or  improve- 
ment; that  which  is  his  personal  concern  or  interest; 
employment,  regular  occupation,  but  it  is  not  necessary 
that  it  should  be  his  sole  occupation  or  employment." 

The  Department  further  states  that:  "The  term  'in  trade,'  as  used  in 
the  law,  is  held  to  mean  the  trade  or  trades  in  which  the  person  making 
the  return  is  engaged;  that  is,  in  which  he  has  invested  money  otherwise 
than  for  the  purpose  of  being  employed  in  isolated  transactions,  and  to 
which  he  devotes  at  least  a  part  of  his  time  and  attention.  A  person  may 
engage  in  more  than  one  trade  and  may  deduct  losses  incurred  in  all  of 
them,  provided,  that  in  each  trade  the  above  requirements  are  met.  As  to 
losses  on  stocks,  grains,  cotton,  etc.,  if  these  are  incurred  by  a  person 
engaged  in  a  trade  to  which  the  buying  or  selling  of  stocks,  etc.,  are  inci- 
dent as  a  part  of  the  business,  as  by  a  member  of  a  stock,  grain,  or  cotton 
exchange,  such  losses  may  be  deducted. 

"A  person  can  be  engaged  in  more  than  one  business  but  it  must  be 
clearly  shown  in  such  cases  that  he  is  actually  a  dealer  or  trader  or  manu- 
facturer, or  whatever  the  occupation  may  be,  and  is  actually  engaged  in 
one  or  more  lines  of  recognized  business  before  losses  can  be  claimed  with 
respect  to  either  or  more  than  one  line  of  business." 

An  individual  may  deduct  as  a  loss  of  business,  his 
share  of  the  loss  of  any  partnership  of  which  he  is  a 
member.1  If,  however,  he  owns  an  interest  in  a  cor- 
poration he  is  not  allowed  to  deduct  the  decrease  in  the 
value  of  stock  holdings  unless  the  loss  is  determined  by 
a  sale  of  the  stock  and  even  then  his  loss  is  treated  as  a 
loss  in  a  stock  transaction  and  not  as  a  loss  in  business.2 

i  In  determining  the  partners'  distributable  profits  or  losses  of  a  part- 
nership that  does  not  own  a  membership  in  a  stock  exchange,  or  if  dealing 
in  securities  does  not  form  part  of  its  regular  business,  losses  actually 
sustained  in  stock  transactions  entered  into  for  profit  may  be  deducted  in 
an  amount  not  exceeding  the  profits  derived  from  similar  transactions 
entered  into  for  profit.  Of  course  if  a  partnership  is  engaged  in  the  busi- 
ness of  purchasing  and  selling  securities,  or  owns  a  membership  in  a  stock 
exchange,  the  full  amount  of  losses  sustained  on  such  transactions  may  be 
deducted. 

1  The  fact  that  the  individual  cannot  dispose  of  the  asset  will  not  alter 
the  above  rule.     If  an  individual   holds  some  worthless   mining  stock  he 


INDIVIDUAL    INCOME    TAX  115 

But  if  he  is  a  dealer  in  securities  he  may  deduct  losses 
on  stock,  even  before  the  stock  is  sold. 

As  far  as  transactions  in  stocks,  etc.,  are  concerned, 
the  Department  has  not  insisted  that  the  individual  or 
partnership  be  a  member  of  the  exchange  in  order  that 
the  transactions  may  constitute  a  business,  but  it  has 
held  that  he  or  the  partnership  must  have  the  standing 
of  a  recognized  dealer  in  securities  or  in  commodities. 

It  is  important  to  remember  that,  for  the  purpose  of 
ascertaining  whether  a  person  is  a  dealer  in  securities, 
etc.,  the  individual  and  the  partnership  of  which  he  is  a 
member  are  treated  as  separate  entities.  The  mere  fact 
that  an  individual  is  a  member  of  a  partnership  engaged 
in  dealing  in  securities,  does  not  permit  the  individual 
to  deduct  losses  resulting  from  stock  transactions  on  his 
own  account  unless  he,  individually,  is  a  recognized 
"dealer." 

To  each  return  there  should  be  attached  a  statement 
of  each  loss  containing  the  following  information: 

a.  What  the  loss  consisted  of. 

b.  When  it  was  actually  sustained. 

c.  How  it  was  determined  to  be  a  loss. 

d.  If  sustained  by  loss  of  property  acquired  prior  to 
March  1,  1913,  the  fair  market  price  or  value  as  of  that 
date  and  how  such  value  was  determined. 

Losses  by  theft. — Losses  of  any  assets  by  theft,  not  en- 
tirely compensated  for  by  insurance  or  otherwise,  are  a 
proper  deduction.  This  includes  losses  of  personal  jew- 
elry, pleasure  or  business  automobiles  and  securities. 
If,  however,  the  theft  represents  a  loss  of  merchandise 
or  the  stock  in  trade  of  the  individual,  and  the  indi- 
vidual computes  his  income  on  the  basis  of  an  annual 
inventory,  then  the  amount  of  loss  cannot  be  claimed, 
inasmuch  as  such  loss  will  be  reflected  in  the  reduced 
inventory  at  the  time  inventory  is  taken  at  the  end  of 

must  actually  sell  the  stock  before  he  is  allowed  to  deduct  the  loss  and 
then  be  subject  to  the  limitations  of  the  taxing  act. 


116  INCOME    AND    FEDERAL    TAX    REPORTS 

the  year.  In  the  latter  case,  if  the  loss  has  been  cov- 
ered by  insurance,  the  insured  should  report  the  insur- 
ance collected  as  income.  But  if  he  has  not  previously 
deducted  the  premiums  in  each  year  as  they  were  paid, 
he  need  report  as  income  only  the  difference  between 
the  amount  collected  and  the  total  insurance  premiums 
paid.  The  loss  offsetting  the  insurance  collected  will 
be  shown  either  in  the  reduced  gross  sales  or  in  the 
reduced  inventory  at  the  end  of  the  period. 

Losses  by  fire  or  the  elements. — Losses  by  fire  of  any 
asset  of  the  individual,  including  even  his  own  residence 
or  a  pleasure  automobile,  and  not  compensated  for  by 
insurance  or  otherwise  are  a  proper  deduction. 

Losses  of  crops,  either  growing  or  harvested,  or  of 
fruit  trees  or  rose  bushes  of  a  grower  through  frost, 
fire,  etc.,  are  not  deductible  as  an  expense.  This  is  for 
the  reason  that  the  actual  cost  of  harvesting  or  pro- 
ducing that  which  has  been  destroyed  is  allowed  as 
an  expense  of  business  in  the  year  in  which  the  ex- 
penses were  incurred,  and  to  permit  the  deduction  of 
the  value  of  the  crops  lost,  in  addition  to  the  deduction 
of  the  expense  of  creating  that  value,  would  result  in 
a  double  deduction,  manifestly  unfair  to  the  govern- 
ment. 

If  the  loss  has  been  covered  by  insurance,  the  insured 
should  report  the  insurance  collected  as  income.  If  he 
has  not  previously  deducted  the  premiums  in  each  year 
as  they  were  paid,  he  need  report  as  income  only  the 
difference  between  the  amount  collected  and  the  total 
insurance  premiums  paid. 

Losses  through  accidents. — Amounts  paid  by  an  em- 
ployer for  an  accident  an  employee  sustains  are  deduc- 
tible expenses.  Likewise,  amounts  paid  to  persons  who 
are  injured  in  the  operation  of  the  plant  or  equipment 
of  a  business  are  deductible.  Thus,  if  an  automobile  is 
operated  for  business  and  runs  over  a  person,  the 
amount  paid  to  such  a  person  is  a  deductible  expense. 


INDIVIDUAL    INCOME    TAX  117 

But  if  the  automobile  were  operated  for  pleasure,  the 
amounts  paid  for  an  injury  resulting  from  an  accident 
cannot  be  deducted  even  though  they  represent  amounts 
paid  through  judgments  rendered. 

LOSSES  OTHER  THAN  FROM  BUSINESS 

Losses  other  than  business  losses. — The  allowance  of 
losses  resulting  from  transactions  not  connected  with 
the  individual's  trade  or  business  is  subject  to  two  re- 
strictions. 

1.  The  loss  must  be  the  result  of  a  transaction  entered 
into  for  profit. 

2.  The  loss  may  be  deducted  only  if  there  is  at  least 
an  equal  amount  of  income  from  transactions  entered 
into  for  profit,  and  not  connected  with  the  individual's 
trade  or  business. 

Losses  sustained  through  fire,  storm,  shipwreck,  or  by 
theft  are  not  included  under  this  heading.  Such  losses, 
not  compensated  for  by  insurance,  may  be  deducted 
without  any  limitation. 

The  loss  must  be  the  result  of  a  transaction  entered  into 
for  profit. — To  be  deductible,  such  losses  must  arise  from 
transactions  actually  entered  into  for  profit  and  not  for 
any  other  purpose.  If  a  transaction  is  entered  into 
merely  for  pleasure  and  not  for  profit,  losses,  if  in- 
curred, could  not  be  deducted. 

The  loss  may  be  deducted  only  as  an  offset  against  profits 
from  similar  transactions. — The  amount  that  may  be  de- 
ducted as  losses  other  than  from  business  is  limited  to 
the  amount  of  profit  during  the  year  from  similar  trans- 
actions.1 This  limitation  does  not  mean  that  a  loss  on 
one  stock  transaction  may  be  offset  only  by  the  profit 
on  another  stock  transaction.    It  does,  however,  mean 

1  To  come  within  the  definition  of  a  "similar  transaction"  the  profit 
must  have  been  realized  in  the  same  manner  as  that  in  which  the  loss  was 
sustained,  i.e.,  if  the  loss  was  sustained  due  to  purchase  and  sale  of  an 
asset,  then  the  profit  to  offset  such  loss  must  have  been  realized  through  a 
purchase  and  a  sale. 


118  INCOME   AND    FEDERAL    TAX   REPORTS 

that  a  loss  on  a  stock  transaction  cannot  be  offset  against 
any  income,  but  against  the  profit  from  another  transac- 
tion entered  into  for  profit  outside  of  the  trade  or  busi- 
ness of  the  individual.  A  loss  on  a  stock  transaction 
cannot  be  offset  against  income  from  rent,  interest  on 
bonds,  dividends  on  stocks,  or  similar  items.  Such 
items  do  not  come  under  the  classification  of  "transac- 
tions entered  into  for  profit  but  not  connected  with  the 
trade  or  business  of  the  individual."  But  the  loss  on 
a  stock  transaction  can  be  deducted  from  the  profit  on  a 
cotton  or  grain  market  operation,  or  from  the  profit  on 
a  sale  of  real  estate,  or  from  the  profit  on  a  foreign 
exchange  speculation. 

A  is  engaged  in  the  manufacturing  business.  In 
1914  he  invested  $20,000  in  real  estate,  but  as  a  result 
of  local  conditions  the  rental  return  decreased  to  such 
an  extent  that  in  1917  he  sold  this  property  for  $14,000, 
thereby  incurring  a  loss  of  $6,000.  Inasmuch  as  he  had 
no  income  from  a  similar  transaction  entered  into  for 
profit,  and  as  the  real  estate  business  was  not  his 
recognized  line  of  business,  A  would  not  be  allowed  to 
charge  off  in  1917  the  loss  of  $6,000  so  sustained. 

Losses  due  to  destruction  of  building. — Losses  due  to  the 
voluntary  removal  or  destruction  of  buildings  made  nec- 
essary by  improvements  to  the  property,  as  when  an 
old  building  is  destroyed  and  a  new  building  erected, 
are  a  charge  to  the  cost  of  the  new  building.  In  no 
case  may  such  "losses"  be  charged  as  a  loss  in  deter- 
mining net  income.  The  amount  which  may  be  added 
to  the  cost  of  the  new  building  is  the  difference  be- 
tween the  cost  of  the  building  removed  and  the  amount 
of  the  depreciation  reserve  already  provided  for  depre- 
ciation of  the  old  building.  The  individual  therefore 
does  not  receive  any  credit  against  his  net  income  on 
account  of  such  a  loss  unless  the  new  building  is  sold. 
In  the  case  of  a  sale  of  the  new  building,  the  loss  or 
profit  on  the  transaction  will  be  the  difference  between 


INDIVIDUAL    INCOME    TAX  119 

the  selling  price  of  the  new  building  on  the  one  hand, 
and  the  cost  of  the  new  building  plus  the  value  of  the 
old  building  at  the  time  it  was  destroyed,  on  the  other 
hand. 

Of  course,  in  calculating  the  depreciation  on  the  new 
building,  the  owner  may  use  as  the  basis  of  depreciation 
calculations  the  construction  cost  of  the  new  building 
plus  the  value  of  the  old  building  at  the  time  it  was 
destroyed. 

The  following  will  illustrate  exactly  what  may  be 
done  in  the  above  cases.  A  constructs  a  building  orig- 
inally costing  $300,000,  and  having  an  estimated  life  of 
30  years.  At  the  end  of  20  years  he  tears  down  the 
old  building,  on  which  he  has  already  deducted  $200r 
000  depreciation,  and  erects  a  new  building  at  an  addi- 
tional cost  of  $900,000,  with  an  estimated  life  of  40 
years.  The  apparent  loss  sustained  in  the  destruction 
of  the  old  building  ($100,000)  may  not  be  deducted  as 
a  loss.  This  loss  of  $100,000  is  charged  to  the  cost  of 
the  new  building,  and  the  following  year  A  may  deduct 
depreciation  on  a  valuation  of  the  new  building  of  $1,- 
000,000.  He  may  therefore  deduct  $25,000  depreciation 
each  year. 

If  A  later  sells  the  new  building  for  $1,400,000  his 
profit  is  $400,000,  not  $500,000.  If  A  sells  the  new 
building  for  $900,000,  his  loss  is  $100,000. 

Losses  sustained  by  the  destruction  of  unsafe  or 
insanitary  buildings  ordered  destroyed  by  the  authori- 
ties of  a  municipality  cannot  be  claimed  as  a  deduction, 
either  as  a  loss  or  as  depreciation. 

But  losses  due  to  the  destruction  of  a  building  by  fire 
or  the  elements  are  properly  deductible,  to  the  extent 
that  they  were  not  covered  by  insurance.  This  is  true, 
even  though  the  building  is  not  used  for  business  pur- 
poses. And  the  amount  of  loss  sustained  in  this  case  is 
not  limited  to  "the  gains  from  similar  transactions." 


120  INCOME   AND    FEDERAL    TAX    REPORTS 

Losses  on  stock  transactions. — The  method  of  determin- 
ing losses  on  stock  transactions  is  as  follows:  A  stock- 
holder's investment  is  in  the  stock  of  a  corporation.  If 
he  disposed  of  his  stock  for  more  than  its  fair  market 
value  on  March  1,  1913,  or  its  cost  if  acquired  since 
that  date,  the  profit  realized  must  be  returned  as  in- 
come; if  he  disposes  of  it  at  a  loss,  the  loss  sustained 
is  deductible  from  gross  income  within  the  limits  of  the 
taxing  act.  In  computing  the  profit  or  loss  sustained 
there  must  be  taken  into  account  dividends  paid  from 
reserves  accumulated  prior  to  March  1,  1913,  which 
were  not  returned  as  income  for  the  year  in  which  re- 
ceived. 

Losses  on  stock  transactions  may  be  deducted  in  full 
by  an  individual: 

1.  If  he  is  a  member  of  a  stock  exchange. 

2.  A  licensed  or  recognized  broker  engaged  in  buying 
and  selling  securities  for  others. 

3.  If  the  buying  and  selling  of  securities  form  a  part 
of  his  regular  business  or  trade.1 

BAD   DEBTS 

Bad  debts  deductible. — The  taxpayer  is  allowed  to  de- 
duct only  such  debts  as  are  actually  ascertained  to  be 
worthless  and  charged  off  within  the  year.  An  indi- 
vidual is  not  allowed  to  deduct  an  estimated  amount  to 
cover  losses  that  may  be  charged  off  in  the  future,  such 
as  "reserves  for  bad  debts."  But  amounts  paid  as 
premiums  for  credit  insurance  are  deductible. 

Debts  which  arise  from  items  of  income  (i.e.,  ac- 
counts receivable  from  sales,  etc.)  and  which  later  prove 
to  be  worthless,  will  not  be  allowed  as  a  deduction, 
unless  the  income  which  they  represent  is  included  in 
the  return,  or  has  been  included  in  a  return  of  a  previ- 
ous year.     Thus  an  individual  would  not  be  allowed  to 

i  See  also  the  treatment  of  this  subject  under  Corporation  Deductions  in 
a  later  chapter,  p.  219.     See  also  p.  60. 


INDIVIDUAL   INCOME   TAX  121 

deduct  as  a  bad  debt  unpaid  salary,  unless  he  had  kept 
his  books  in  such  manner  as  to  include  the  salary  as 
income  when  it  was  earned. 

Debts  due  and  payable  prior  to  March  1,  1913,  and 
not  ascertained  to  be  worthless  prior  to  that  date,  are 
proper  deductions  in  the  year  when  they  are  actually 
ascertained  to  be  worthless,  and  are  charged  off  as 
uncollectible. 

Where  the  debtor  is  an  individual,  or  partnership, 
the  Treasury  Department  does  not  require  the  creditor 
to  secure  a  judgment  against  the  debtor  and  proceed 
upon  the  judgment,  before  allowing  him  to  deduct  the 
debt.  It  does,  however,  require  him  to  show,  beyond  a 
reasonable  doubt  (taking  into  consideration  the  time  the 
debt  has  run  and  the  financial  conditioning  of  the 
debtor),  that  the  debt  is  worthless  and  uncollectible. 

Where  the  debtor  is  a  corporation  possessed  of  assets 
no  deduction  can  be  claimed  until  the  corporation's 
affairs  are  finally  closed  and  its  receiver  in  bankruptcy 
discharged. 

Where  a  creditor  makes  a  compromise  agreement  or 
common  law  settlement  with  the  debtor  and  accepts  a 
part  of  the  debt  as  full  payment  releasing  the  debtor 
from  payment  of  the  balance,  he  may  deduct  the  unpaid 
portion  as  a  bad  debt.  The  same  rule  applies  if  the 
creditor  accepts  a  composition  settlement  in  bankruptcy. 
But  if  A  claimed  that  B  owed  him  $1,000,  and  B  con- 
tested the  claim,  but  agreed  to  pay  $500  to  settle  it,  A 
could  not  deduct  the  balance  which  he  contended  was 
due  him.  This  case  differs  from  the  preceding  one  in 
that  there  is  a  contest  as  to  the  amount  of  the  indebt- 
edness. 

If  the  debtor  corporation  has  no  assets  whatsoever 
and  it  is  definitely  known  that  nothing  whatsoever  can 
be  collected  from  the  debtor  itself  or  any  person  con- 
nected with  it,  a  creditor  need  not  go  to  the  expense 
of  instituting  bankruptcy  proceedings  in  order  to  es~ 


122  INCOME   AND    FEDERAL    TAX   REPORTS 

tablish  his  right  to  claim  the  worthless  debt  as  a  deduc- 
tion. 

Should  an  individual  endorse  a  note  and  later  be 
obligated  to  make  good  the  payment  of  the  instrument 
by  reason  of  the  insolvency  of  the  maker,  he  may 
charge  off  the  amount  involved  as  a  bad  debt  after  he 
has  actually  paid  it,  unless  at  the  time  of  his  endorse- 
ment, he  was  aware  the  maker  was  insolvent. 

Bad  debts  arising  from  transactions  not  connected  with 
business. — Any  bad  debt  is  deductible;  it  is  not  neces- 
sary that  it  should  be  one  which  has  arisen  out  of  trans- 
actions connected  with  the  individual's  trade  or  business. 
Thus,  a  personal  loan  which  proves  uncollectible  is  a 
proper  deduction.  The  purchase  price  of  a  bond  or 
note  purchased  for  investment  (and  not  for  speculative 
purposes)  which  proves  to  be  worthless,  is  deductible. 
There  is  absolutely  no  limitation  imposed  on  the  amount 
of  bad  debts  which  may  be  deducted. 

Losses  sustained  incident  to  foreclosure  of  a  mortgage. — 
A  loss  sustained  by  a  mortgagee  in  the  foreclosure  of  a 
mortgage  is  deductible,  providing  the  debt  represented 
by  the  bond  or  note  of  the  mortgagor  is  uncollectible. 

DEPRECIATION 

Depreciation  deductible. — The  amount  that  may  be  de- 
ducted under  this  heading  is  limited  to  a  reasonable 
allowance  for  the  exhaustion,  and  wear  and  tear  of 
property,  arising  out  of  its  use  or  employment  in  busi- 
ness or  trade.  This  deduction  is  permitted  even  though 
the  property  has  not  actually  been  used,  as  when  a 
plant  remains  idle,  because  of  adverse  business  or  other 
conditions.  In  such  a  case  the  amount  of  depreciation 
allowed  will  usually  be  less  than  if  it  had  been  in  oper- 
ation. The  fact  that  the  property  may  have  been  ac- 
quired by  gift  does  not  prevent  a  reasonable  allowance 
for  depreciation  from  being  deducted,  providing,  of 
course,  that  the  property  is  used  for  business  purposes. 


INDIVIDUAL    INCOME    TAX  123 

But  no  depreciation  is  allowed  on  a  building  occupied 
as  a  residence  by  the  owner.  If  the  building  is  also 
partly  rented  to  one  or  more  tenants,  a  proportionate 
part  of  the  depreciation  may  be  deducted.1 

Where  in  the  course  of  years,  the  owner  of  property 
has  claimed  its  full  cost  as  depreciation  in  his  income 
tax  returns,  no  further  claim  for  depreciation  will  be 
allowable.  Kepairs,  however,  will  nevertheless  be  al- 
lowable. 

The  methods  of  determining  the  amount  of  deprecia- 
tion that  may  be  deducted  each  year  are  fully  discussed 
in  the  Chapter  on  Corporate  Income  Tax,  Depreciation. 

Depreciation  on  personal  items. — Depreciation  is  not 
allowable  on  items  used  for  personal  pleasure  or  con- 
venience, such  as  pleasure  automobiles,  etc.  Deprecia- 
tion is  allowed  only  when  the  property  itself  is  used 
for  the  purpose  of  producing  income.  It  will  also  be 
allowed  when  property  is  vacant  and  the  owner  intends 
to  use  it  for  business  purposes. 

If  the  article  is  used  for  both  business  and  pleasure, 
depreciation  may  be  deducted  in  proportion  to  the 
amount  of  business  use  the  article  received. 

Depreciation  in  land  values. — Depreciation  in  the  value 
of  land  is  not  allowable  as  a  deduction,  nor  must  appre- 
ciation in  the  value  of  the  land  be  reported  as  income, 
until  the  land  is  sold.  And  this  is  true  even  when  de- 
preciation is  deducted  on  the  building  standing  on  the 
land. 

Depletion. — The  question  of  depletion  of  oil  wells, 
mines,  etc.,  is  discussed  under  "Corporate  Income  Tax," 
which  see  also  for  a  complete  discussion  of  other  forms 
of  depletion.     See  p.  233. 

No  deductions  allowed  for  improvements,  etc. — No  deduc- 
tion is  allowed  for  payments  for  new  buildings,  per- 
manent improvements,  or  for  betterments  made  to  in- 
crease the  value  of  the  property.    The  distinction  be- 

i  See  page  104. 


124  INCOME   AND   FEDERAL    TAX   REPORTS 

tween  an  improvement  and  a  repair  is  very  often  a  fine 
one.1  The  distinction  is  brought  out  in  the  following 
three  citations: 

(1)  The  most  commonly  accepted  is  that  in  so  far 
as  the  transaction  results  in  an  addition  of  substantial 
and  permanent  character  which  increases  the  value  of 
the  plant,  such  increase  is  a  capital  expense  and  should 
be  charged  to  the  construction  account.  (Mackintosh 
vs.  Flint  £  Pere  Marquette  Ry.  34.  Fed.  Rep.  60).  Or, 
as  it  is  clearly  expressed  in  Hubbard  vs.  Weare: 
"Money  paid  out  should  not  be  reckoned  as  an  asset. 
If  paid  for  property  that  is  on  hand,  the  property  is  an 
asset.  If  expended  in  a  way  that  has  enhanced  the 
value  of  the  general  assets  it  is  included  in  its  valua- 
tion. If  so  expended  as  to  have  brought  no  property, 
and  no  enhancement  of  that  on  hand,  then  it  is  a  loss, 
and  should  not  be  counted  as  an  asset."     (79  la.  678.) 

(2)  A  more  extreme  view  is  that  expressed,  for  in- 
stance, by  T.  F.  Woodlock:  "An  addition  which  does 
not  increase  revenue  or  diminish  expenditure  is  not 
a  proper  capital  charge  according  to  the  best  modern 
practice  in  railroads.  That  which  simply  tends  to  hold 
business  and  not  to  increase  business  is  a  proper 
charge  against  operating  expenses.''2 

(3)  At  the  other  extreme  is  the  view,  presented  in  the 
decision  by  Lord  Kyllachy  in  Cox  vs.  Edinburgh  and 
District  Tramways  Company,  him.  (6  S.  L.  T.  63) 
(1898)  that  where  an  improvement  is  made  in  the  plant, 
even  though  it  be  in  the  nature  of  the  substitution  of 
a  new  plant  for  old,  the  entire  cost  of  the  new  plant, 
and  not  merely  the  excess  in  value  of  the  new  over 
the  old,  may  be  charged  to  construction  account. 

Of  these  three  views  the  first  is  not  only  the  most 
generally   accepted   but   seems    to    comport   best   with 

i  See  also  Chapter  on  Corporation  Deductions  for  further  treatment  of 
repairs  and  renewals  and  depreciation,  pp.  221-233. 

2  Engineering  Magazine,  Vol.  xi,  p.  241. 


INDIVIDUAL    INCOME    TAX  125 

accounting  principles.  It  has  furthermore  been  author- 
itatively adopted  for  railway  accounting  by  the  Inter- 
state Commerce  Commission.  The  second  view,  while 
praised  for  its  conservatism  seems  to  imply  that  there 
must  be  a  constant  rate  of  normal  interest  or  profits, 
a  condition  denied  by  economic  history.  If  a  general 
decline  in  profits  occurs,  an  improvement  which,  in  a 
given  enterprise,  prevents  the  fall  and  maintains  the 
old  rate  of  profits  is  clearly  a  source  of  additional 
value,  and  would  be  capitalized  in  the  money  market. 
The  third  view  is  rarely  justified  by  accountants.1 

i  Hatfield,  Modern  Accounting. 


CHAPTER  V 

INDIVIDUAL  INCOME  TAX 

RATE  OF  TAX 

On  whom  imposed. — Citizens  and  residents  of  the 
United  States,  including  the  territories  of  Alaska  and 
Hawaii  and  the  District  of  Columbia,  are  subject  to  two 
distinct  taxes  on  their  income  for  the  calendar  year  of 
1917. 

The  original  Income  Tax  law,  as  amended  September 
8,  1916,  remains  in  force,  subject  to  some  modifications 
caused  by  the  act  of  October  3,  1917.  This  act,  under 
Title  I,  imposed  an  additional  tax  on  the  net  income  of 
every  individual,  a  citizen  or  resident  of  the  United 
States. 

Non-resident  aliens  are  not  subject  to  the  normal  tax 
imposed  by  the  1917  law,  but  they  are  subject  to  the 
super-taxes  imposed  by  that  law.  They  are  not  allowed  to 
deduct  the  specific  exemption  allowed  under  the  1916  law. 

Citizens  of  the  Philippines  and  Porto  Rico  are  con- 
sidered citizens  of  the  United  States  under  the  1916  law, 
but  they  are  specifically  exempt  from  the  provisions  of 
the  1917  law. 

The  liability  of  the  different  classes  of  individuals  to 
the  various  taxes  is  clearly  shown  by  the  following  table : 

Normal  Normal  Super-tax     Super -tax 

Class  tax  1916  tax  1917         1916  1917 

Citizens  and  residents  of  the  United 

States    Yes            Yes  Yes  Yes 

Non-resident    alien    individuals ....    Yes *          No  Yes  Yes 
Residents    of    Porto    Rico    and    the 

Philippines     Yes             No  Yes  No 

i  Non-resident  aliens  are  not  now  allowed  the  specific  exemption  of 
$3,000  or  $4,000. 

126 


INDIVIDUAL    INCOME    TAX  127 

Rates  under  1916  law. — The  1916  law  levies  a  normal 
or  base  tax  at  the  rate  of  2  per  cent  on  the  net  income 
of  every  citizen  or  resident  of  the  United  States  and 
every  non-resident  alien,  and  in  addition  levies  sur- 
taxes as  follows: 

On  net  income  in  excess  of     $20,000  and  not  over      $40,000 1% 

On  net  income  in  excess  of        40,000  and  not  over        60,000 2 

On  net  income  in  excess  of       60,000  and  not  over        80,000 3 

On  net  income  in  excess  of        80,000  and  not  over      100,000 4 

On  net  income  in  excess  of      100,000  and  not  over      150,000 5 

On  net  income  in  excess  of      150,000  and  not  over      200,000 6 

On  net  income  in  excess  of     200,000  and  not  over     250,000 7 

On  net  income  in  excess  of     250,000  and  not  over      300,000 8 

On  n<^t  income  in  excess  of      300,00J  and  not  over      500,000 9 

On  net  income  in  excess  of     500,000  and  not  over  1,000,000 10 

On  net  income  in  excess  of  1,000,000  and  not  over  1,500,000 11 

On  net  income  in  excess  of  1,500,000  and  not  over  2,000,000 12 

On  net  income  in  excess  of  2,000,000 13 

Deductions  from  net  income  allowed  for  normal  tax  un- 
der 1916  law. — 1.  Specific  exemptions  of  $3,000  or  $4,000. 
For  the  purpose  of  the  normal  tax  only,  every  individ- 
ual (except  non-resident  aliens)  is  allowed  to  deduct 
from  his  income  the  sum  of  $3,000  as  an  exemption. 
Thus,  if  a  man's  income  is  $5,000,  he  may  deduct 
$3,000,  and  the  2  per  cent  tax  will  be  imposed  on  only 
$2,000. 

If  the  person  making  the  return  is  the  head  of  a 
family,  or  a  married  man  with  a  wife  living  with  him, 
or  a  married  woman  with  a  husband  living  with  her,  he 
or  she  is  allowed  an  exemption  of  $4,000.  For  defini- 
nition  of  head  of  family  see  next  section. 

If  the  husband  and  wife  are  living  together,  only  one 
deduction  of  $4,000  may  be  made  from  their  aggregate 
income. 

The  income  of  husband  and  wife  need  be  combined 
only  for  the  normal  tax.1  Surtaxes  will  be  levied  on 
the  separate  incomes. 

i  The  parent  is  held  to  be  the  natural  guardian  of  the  minor  child.  In- 
come received  by  a  minor  child  from  sources  other  than  the  parent  should 
be  included  by  the  parent  in  his  return  of  income.     The   fact  that  such 


128  INCOME    AND    FEDERAL    TAX    REPORTS 

If  husband  and  wife  are  living  apart,  each  is  entitled 
to  an  exemption  of  $3,000. 

If  the  person  making  the  return  is  married  or  is  the 
head  of  a  family,  he  is  allowed,  in  addition  to  the  ex- 
emption of  $4,000,  $200  for  each  dependent  child  who 
is  under  18  years  of  age  or  else  incapable  of  self-sup- 
port because  of  mental  or  physical  defect.  This  $200 
additional  exemption  is  not  allowed  for  other  de- 
pendents. 

The  single  or  married  status  of  a  person  claiming 
the  specific  exemption  is  determined  as  of  the  close  of 
the  year  for  which  the  return  is  made. 

Guardians  or  trustees  are  allowed  to  make  this  per- 
sonal exemption  of  $3,000  or  $4,000  from  the  income 
derived  from  the  property  of  which  they  have  charge, 
in  favor  of  each  ward  or  cestui  que  trust  (beneficiary). 

An  exemption  of  $3,000  is  allowed  from  the  net  in- 
come of  a  decedent's  estate  during  its  administration  or 
settlement,  even  though  the  period  be  less  than  one 
year,  and  from  a  trust  or  other  estate  the  income  of 
which  is  not  distributed  annually  or  regularly. 

Where  a  person  dies  during  the  year,  his  executor, 
in  filing  the  return  of  decedent's  income,  may  claim  the 
full  specific  exemption  of  $3,000  or  $4,000,  as  the  case 
may  be,  according  to  the  marital  status  of  such  person 
at  the  time  of  his  death. 

2.  Dividends. — To  arrive  at  the  net  income  on  which 
the  normal  tax  will  be  applied,  dividends  received  from 
domestic  corporations  should  also  be  deducted.     The 

income  is  not  appropriated  by  the  parent  is  immaterial,  as  it  will  be 
held,  in  the  absence  of  a  showing  of  fact  to  the  contrary,  that  such  income 
was  subject  to  appropriation  by  the  parent  and  that  the  child  receives  the 
same  as  a  gift  from  the  parent. 

When  the  income  is  from  a  separate  estate  and  the  parent  has  been 
appointed  guardian  and  the  facts  are  such  that  the  income  so  received  is 
to  be  held  for  the  use  of  the  child,  it  should  not  be  included  in  the  return 
of  income  for  the  parent,  but  should  be  accounted  for  otherwise  for  the 
purpose  of  the  Income  Tax  in  the  manner  and  form  called  for  by  the 
facts  of  the  particular  case.     See  Chapter  on  Fiduciaries,  p.  288. 


INDIVIDUAL    INCOME    TAX  129 

amount  deducted  should  include  only  dividends  from 
domestic  corporations,  joint-stock  companies,  Massa- 
chusetts trusts,  associations  and  insurance  companies, 
dividends  from  foreign  corporations  whose  entire  net 
income  is  from  sources  within  the  United  States,  and 
also  profits  from  limited  partnerships.  The  income  of 
all  these  organizations  is  subject  to  the  Corporation 
Income  Tax  when  earned.  To  tax  their  income  again 
when  distributed  would  be  a  form  of  double  taxation. 
Dividends  and  profits  from  organizations  which  are  sub- 
ject to  the  income  tax  are  exempt  from  the  normal  tax 
of  both  laws.  They  are,  however,  subject  to  the  sur- 
taxes imposed  by  both  laws,  provided  they  were  paid 
out  of  1917  surplus  or  undivided  profits.  If  the  divi- 
dends were  paid  out  of  surplus  or  undivided  profits  ac- 
cumulated in  1916 l  they  are,  by  the  provisions  of  the  law 
(sec.  31),  subject  to  the  super-taxes  at  the  rates  in  ef- 
fect for  the  year  1916.  This  means  that  they  are  not 
subject  to  the  super- tax  imposed  by  the  1917  law.  Divi- 
dends paid  from  surplus  acquired  in  the  years  1913 
to  1915  inclusive  are  subject  to  the  super-taxes  in 
effect  for  that  period.2  The  super-taxes  for  the  period 
from  1913  to  1915  are  the  same  as  those  for  1916  until 
the  net  income  exceeds  $40,000.  Above  that  amount, 
the  rates  in  the  1916  law  are  a  trifle  higher.  Individ- 
uals with  an  income  in  excess  of  $40,000  who  have  re- 
ceived dividends  paid  out  of  surplus  earned  in  the 
years  1913,  1914  and  1915  are  entitled  to  take  credit 
on  the  returns  for  the  amount  by  which  the  surtax  on 

i  In  the  case  of  profits  distributed  out  of  the  most  recent  earnings  of  a 
corporation  which  closes  its  books  as  of  June  30,  1917,  so  much  of  the 
dividend  as  represented  the  distribution  of  earnings  for  the  period  Janu- 
ary 1  to  January  30,  1917,  inclusive,  would  be  subject,  in  the  hands  of 
the  stockholders  receiving  same,  to  the  graduated  additional  taxes  imposed 
by  the  aet  of  September  8,  1916,  as  amended,  and  the  act  of  October  3, 
1917,  and  so  much  of  it  as  represented  a  distribution  of  profit  or  surplus 
accumulated  in  1916  would  be  subject  to  additional  tax  at  the  1916  rate. 

2  For  the  method  of  determining  out  of  which  year's  surplus  the  divi- 
dend was  paid,  see  pp.  78-88. 


130  INCOME    AND    FEDERAL    TAX    REPORTS 

such  dividends  as  figured  under  the  1916  law  exceeds 
the  amount  as  figured  under  the  1913  law.  (See  Com- 
putation of  Tax,  next  chapter.) 

3.  Interest  on  bonds  of  the  second  Liberty  Loan,  i.e., 
first  and  second  4s.  Interest  on  bonds  of  the  first  Lib- 
erty Loan  is  entirely  exempt  from  the  tax  and  should 
not  appear  in  the  return. 

Head  of  family. — For  the  purpose  of  the  personal  ex- 
emption, the  head  of  a  family  is  held  to  be  any  per- 
son who  actually  supports  and  maintains  one  or  more 
individuals  who  are  closely  connected  with  him  by  blood 
relationship,  relationship  by  marriage  or  adoption,  and 
whose  right  to  exercise  family  control  and  provide  for 
these  dependent  individuals  is  based  upon  some  moral 
or  legal  obligations.  For  example,  the  oldest  son  of  a 
family  supporting  a  widowed  mother  and  several  minor 
children  would  come  within  this  class.  In  some  cases 
there  may  be  two  members  of  a  family,  each  of  whom 
is  the  "head  of  a  family."  For  example,  A  and  B  are 
brothers  supporting  a  mother  and  a  grandmother.  A 
and  B  may  each  claim  to  be  the  head  of  a  family,  as 
each  is  supporting  one  dependent.  Each  may  therefore 
claim  an  exemption  of  $4,000. 

Deductions  from  net  income  allowed  for  super-tax  com- 
putation.— 1.  Interest  received  on  bonds  of  the  second 
Liberty  Loan  is  deductible  from  the  net  income  for  the 
purpose  of  the  super-tax  only  to  the  extent  that  such  in- 
terest is  from  a  principal  of  $5,000  or  less.  The  maximum 
deduction  in  any  one  year  would  therefore  be  $200.* 

2.  Interest  paid  on  obligations  incurred  in  the  pur- 
chase of  bonds  of  the  second  Liberty  Loan,  either  first 
or  second  4s,  is  deductible  for  the  purpose  of  the  super- 
tax.2   Interest  paid  on  obligations  incurred  in  the  pur- 

i  For  the  year  1917  the  maximum  deduction  will  be  $25.  The  bonds 
bear  interest  from  November  15,  1917.  A  person  selling  them  December 
31,  1917,  would  get  iy2  month's  interest. 

2  The  amount  of  interest  deductible  is  that  proportion  of  total  interest 
payments  which  the  excess  over  $5,000  is  to  the  total  amount  of  such  bonds 
purchased.     See  Chapter  on  Returns,  Form  1040,  Division  E,  p.  149. 


INDIVIDUAL    INCOME   TAX  131 

chase  of  bonds  of  the  first  Liberty  Loan,  i.e.,  the  3y2s, 
is  not  deductible.  But  if,  while  the  obligation  was  still 
in  force,  the  3y2  per  cent  bonds  were  converted  into  the 
4  per  cent  bonds,  the  interest  on  the  loan  from  the  date 
of  conversion  may  be  deducted. 

Rates  under  1917  law. — The  law  of  October  3,  1917, 
levies  an  additional  normal  tax  of  2  per  cent  on  the 
net  income  of  every  individual,  a  citizen  or  resident  of 
the  United  States.  Non-resident  aliens,  and  citizens  of 
Porto  Eico  and  the  Philippines  are  not  subject  to  the 
normal  taxes  imposed  by  this  law. 

The  1917  law  imposes  additional  surtaxes  on  all  in- 
dividuals, including  non-resident  aliens,  and  excluding 
citizens  of  Porto  Rico  and  the  Philippines,  as  follows: 


Total  surtax 

On  net  income 

and  not 

Supertax  imposed 

including  1916 

in  excess  of 

over 

bv  1917  act1 

and  1917  rates1 

$5,000 

$7,500 

1% 

1% 

7,500 

10,000 

2 

2 

10,000 

12,500 

3 

3 

12,500 

15,000 

4 

.      4 

15,000 

20,000 

5 

5 

20,000 

40,000 

7 

8 

40,000 

60,000 

10 

12 

60,000 

80,000 

14 

17 

80,000 

100,000 

18 

22 

100,000 

150,000 

22 

27 

150,000 

200,000 

25 

31 

200,000 

250,000 

30 

37 

250,000 

300,000 

34 

42 

300,000 

500,000 

37 

46 

500,000 

750,000 

40 

50 

750,000 

1,000,000 

45 

55 

1,000,000 

1,500,000 

50 

61 

1,500,000 

2,000,000 

50 

62 

2,000,000 

50 

63 

Deductions  from  net  income  allowed  for  1917  normal  tax. 
-The  deductions  for  the  normal  tax  allowed  under  the 

i  The  Excess  Profits  tax  rates  are  not  included  in  this  table. 


132  INCOME   AND    FEDERAL    TAX    REPORTS 

1916  law  are  allowed  under  the  1917  law,  with  the  ex- 
ceptions that: 

1.  The  personal  exemption  is  reduced  to  $1,000  for 
individuals  other  than  married  persons  or  heads  of 
families. 

2.  The  personal  exemption  for  married  individuals 
or  heads  of  families  is  reduced  to  $2,000  plus  an  extra 
allowance  of  $200  for  each  dependent  child. 

3.  Personal  exemption  on  income  of  decedent  prior 
to  his  death  is  reduced  to  $1,000  or  $2,000,  according 
to  his  marital  status  at  the  time  of  his  death. 

4.  Deduction  allowed  to  estates  pending  settlement 
and  on  undistributed  income  of  trust  estates  is  reduced 
to  $1,000. 

Another  difference  between  the  1916  and  1917  laws, 
as  far  as  deductions  are  concerned,  is  that  the  latter 
permits  the  deduction  of  such  part  of  the  income  from 
partnerships  distributable  during  the  year  as  is  tax- 
able, according  to  the  provisions  of  section  8,  paragraph 
(e)  of  the  law,  at  the  rates  in  effect  for  the  year  1916. 
This  section  provides  that  a  partnership  may  establish 
a  fiscal  year  and  that  the  income  of  the  partnership 
in  that  case  shall  be  prorated,  as  between  1916  and 
1917,  on  the  basis  of  the  number  of  months  of  their 
fiscal  year  falling  within  the  calendar  year.  To  illus- 
trate: The  partnership  of  A  and  B  for  the  fiscal  year 
ending  June  30,  1917,  earned  $100,000,  of  which  A  was 
entitled  to  $60,000  and  B  to  $40,000.  Of  this  $100,000, 
six-twelfths  (the  number  of  months  falling  in  1917), 
or  $50,000,  is  taxable  at  the  rates  in  effect  for  the 
year  1917,  that  is,  the  rates  in  effect  for  the  year  1916 
plus  the  1917  rates;  the  balance  of  $50,000  is  taxable 
only  at  the  1916  rates.  A  will  report  his  $60,000  as 
income  from  partnership,  and  in  calculating  his  tax 
will  deduct  one-half  or  $30,000,  from  his  net  income, 
and  pay  the  taxes  in  effect  for  the  year  1917  only  on 
the  remaining  $30,000.  This  $30,000  deducted  is  sub- 
ject to  tax  only  at  the  1916  rates. 


INDIVIDUAL    INCOME    TAX 


133 


RATES  OF  TAX  BASED  ON  A  PERSONAL  EXEMPTION  OF  $4,000 
AND  $2,000  UNDER  THE  1916  AND  1917  LAWS   RESPEC- 
TIVELY* 


Income 


Nor- 

Nor- 

Total 

Super- 

Super- 

Total 

mal, 

mal, 

Nor- 

tax, 

tax, 

Super- 

1916 

1917 

mal 

1916 

1917 

tax 

2% 

2% 

2 

4 

2% 

2 

4 

2 

2 

4 

'l% 

i% 

2 

2 

4 

2 

2 

2 

2 

4 

3 

3 

2 

2 

4 

4 

4 

2 

2 

4 

5 

5 

2 

2 

4 

'i% 

7 

8 

2 

2 

4 

2 

10 

12 

2 

2 

4 

3 

14 

17 

2 

2 

4 

4 

18 

22 

2 

2 

4 

5 

22 

27 

2 

2 

4 

6 

25 

31 

2 

2 

4 

7 

30 

37 

2 

2 

4 

8 

34 

42 

2 

2 

4 

9 

37 

46 

2 

2 

4 

10 

40 

50 

2 

2 

4 

10 

45 

55 

2 

2 

4 

11 

50 

61 

2 

2 

4 

12 

50 

62 

2 

2 

4 

13 

50 

63 

Total 
Tax 


$1,000  to 
2,000  to 
3,000  to 
4,000  to 
5,000  to 

7,500  to 
10,000  to 
12,500  to 
15,000  to 
20,000  to 

40,000  to 

60,000  to 

80,000  to 

100,000  to 

150,000  to 


$2,000. 
3,000. 
4,000. 
5,000. 
7,500. 

10,000. 
12,500. 
15,000. 
20,000. 
40,000. 

60,000. 

80,000. 
100,000. 
150,000. 
200,000. 


200,000  to  250,000. 
250,000  to  300,000. 
300,000  to  500,000. 
500,000  to  750,000. 
750,000  to  1,000,000. 

1,000,000  to  1,-500,000. 
1,500,000  to  2,000,000. 
2,000,000  and  over. . . . 


2% 
4 
4 
5 

6 
7 
8 
9 
12 

16 
21 
26 
31 
35 

41 
46 
50 
54 
59 

65 
66 
67 


*  The  rates  of  tax  for  individuals  who  are  unmarried  and  have  no  de- 
pendents are  exactly  the  same  as  shown  above,  except  that  the  1916  normal 
tax  begins  at  $3,000,  and  the  1917  normal  tax  begins  at  $1,000.  The  total 
tax  rates  on  such  persons  are  as  follows:  $1,000  to  $3,000,  2%;  $3,000  to 
$5,000,  4%;  $5,000  to  $7,500  and  above  this,  the  rates  are  the  same  as  shown 
in  the  last  column  in  the  table. 


134 


INCOME   AND    FEDERAL    TAX    REP0RT8 


INCOME 
BASED  ON  A  PERSONAL  EXEMPTION  OF  $4,000  AND 


(1) 

(2) 

(3) 

(4) 

(5) 

Taxable 

1916 

1916 

1916 

1917 

1917 

Income 

Normal  Tax 

Supertax 

Total  Tax 

Normal  Tax 

Supertax 

$1,000 

2,000 

.... 

3,000 

"26 

.... 

4,000 

40 

5,000 

"20 

"26 

60 



6,000 

40 

40 

80 

10 

7,000 

60 

60 

100 

20 

8,000 

80 

80 

120 

35 

9,000 

100 

100 

140 

55 

10,000 

120 

120 

160 

75 

12,500 

170 

170 

210 

150 

15,000 

220 

220 

260 

250 

20,000 

320 

320 

360 

500 

25,000 

420 

' '  50 

470 

460 

850 

30,000 

520 

100 

620 

560 

1,200 

40,000 

720 

200 

920 

760 

1.900 

50,000 

920 

400 

1,320 

960 

2,900 

60,000 

1,120 

600 

1,720 

1,160 

3,900 

75,000 

1,420 

1,050 

2,470 

1,460 

6,000 

80,000 

1,520 

1,200 

2,720 

1,560 

6,700 

100,000 

1,920 

2,000 

3,920 

1,960 

10,300 

125,000 

2,420 

3,350 

5,670 

2,460 

15,800 

150,000 

2,920 

4,500 

7,420 

2,960 

21,300 

200,000 

3,920 

7,500 

11,420 

3,960 

33,800 

250.000 

4,920 

11,000 

15,920 

4,960 

48,800 

300,000 

5,920 

15,000 

20,920 

5,960 

65,800 

400,000 

7,920 

24,000 

31,920 

7,960 

102,800 

500,000 

9,920 

33,000 

42,920 

9,960 

139,800 

600,000 

11,920 

43,000 

54,920 

11,960 

179,800 

750,000 

14,920 

58,000 

72,920 

14,960 

239,800 

1,000,000 

19,920 

83,000 

102,920 

19,960 

352,300 

1,500,000 

29,920 

138,000 

167,920 

29,960 

602,300 

2,000,000 

39,920 

198,000 

237,920 

39,960 

852,300 

Column  1  is  the  amount  of  the  normal  tax  imposed  by  the  law  of  Sept.  8, 

1916.  Allowance  is  made  for  a  personal  exemption  of  $4,000. 

Column  2  is  the  amount  of  the  supertax  imposed  by  the  law  of  Sept.  8,  1916. 

Column  3  is  the  amount  of  total  tax,  both  normal  and  supertax,  imposed  by 
the  Law  of  Sept.  8,  1916.    Allowance  is  made  for  a  personal  exemption  of  $4,000. 

Column  4  is  the  amount  of  normal  tax  imposed  by  the  law  of  Oct.  3,  1917. 
Allowance  is  made  for  a  personal  exemption  of  $2,000. 

Column  5  is  the  amount  of  supertax  imposed  by  the  law  of  Oct.  3,  1917. 

Column  6  is  the  amount  of  the  total  tax  imposed  by  the  law  of  Oct.  3, 

1917.  Allowance  is  made  for  a  personal  exemption  of  $2,000. 

Column  7  is  the  total  tax  imposed  by  both  laws  and  is  the  amount  of  tax 
that  will  be  paid  by  citizens  and  residents  of  the  United  States  who  are  mar- 


INDIVIDUAL    INCOME    TAX  135 

TAX  CHART 

$2,000  UNDER  THE  1916  AND  1917  LAWS  RESPECTIVELY 


(6) 

(7) 

(8) 

(9) 

(10) 

1917 

Total  Tax 

1916  Tax 

1917  Tax 

Total  Tax 

,  Taxable 

Total  Tax 

for  1917 

Actual  % 

Actual  % 

Actual  % 

Income 

of  Income 

of  Income 

of  Income 

$1,000 

2,000 

"20 

' '  20 

.67 

.67 

3,000 

40 

40 

1.00 

1.00 

4,000 

60 

80 

.40 

1.20 

1.60 

5,000 

90 

130 

.67 

1.50 

2.17 

6,000 

120 

180 

.86 

1.71 

2.57 

7,000 

155 

235 

1.00 

1.94 

2.94 

8,000 

195 

295 

1.11 

2.16 

3.27 

9,000 

235 

355 

1.20 

2.35 

3.55 

10,000 

360 

530 

1.36 

2.88 

4.24 

12,500 

510 

730 

1.47 

3.40 

4.87 

15,000 

860 

1,180 

1.60 

4.30 

5.90 

20,000 

1,310 

1,780 

1.88 

5.24 

7.12 

25,000 

1,760 

2,380 

2.07 

5.87 

7.94 

30,000 

2,660 

3,580 

2.30 

6.65 

8.95 

40,000 

3,860 

5,180 

2.64 

7.72 

10.36 

50,000 

5,060 

6,780 

2.87 

8.43 

11.30 

60,000 

7,460 

9,930 

3.29 

9.95 

13.24 

75,000 

8,260 

10,980 

3.40 

10.32 

13.72 

80,000 

12,260 

16,180 

3.92 

12.26 

16.18 

100,000 

18,260 

23,930 

4.54 

14.61 

19.15 

125,000 

24,260 

31,680 

4.95 

16.17 

21.12 

150,000 

37,760 

49,180 

5.71 

18.88 

24.59 

200,000 

53,760 

69,680 

6.37 

21.50 

27.87 

250,000 

71,760 

92,680 

6.97 

23.92 

30.89 

300,000 

110,760 

142,680 

7.98 

27.69 

35.67 

400,000 

149,760 

192,680 

8.58 

29.95 

38.53 

500,000 

191,760 

246,680 

9.15 

31.96 

41.11 

600,000 

254,760 

327,680 

9.72 

33.97 

43.69 

750,000 

372,260 

475,180 

10.29 

37.23 

47.52 

1,000,000 

632,260 

800,180 

11.19 

42.15 

52.34 

1,500,000 

892,260 

1,130,180 

11.90 

44.61 

56.51 

2,000,000 

ried  or  have  dependents,  for  the  calendar  year  1917.  The  taxpayer  may  sub- 
tract from  these  taxes,  $4  for  each  dependent  under  18  years  of  age,  or  incap- 
able of  self-support  due  to  mental  or  physical  disability,  if  the  tax  is  $40  or 
less.  If  the  tax  is  above  $40,  he  may  subtract  an  additional  $4  for  each  such 
dependent  from  the  amount  of  the  tax  above  $40. 

Column  8  is  the  actual  per  cent  of  income  taken  by  the  tax  under  the  1916 
law. 

Column  9  is  the  actual  per  cent  of  income  taken  by  the  tax  under  the  1917 
law. 

Column  10  is  the  actual  per  cent  of  income  taken  by  the  total  tax  for  the 
year  1917. 


136 


INCOME   AND    FEDERAL    TAX    REPORTS 


EFFECT  OF  TOTAL  TAX  ON 


Taxable 
Income 


3M's 


4's 


43^'s 


5's 


$2,000 
3,000 
4,000 
5,000 
6,000 

7,000 

8,000 

9,000 

10,000 

12,500 

15,000 
20,000 
25,000 
30,000 
40,000 

50,000 
60,000 
75,000 
80,000 
100,000 

125,000 
150,000 
200,000 
250,000 
300,000 

400,000 
500,000 
600,000 
750,000 
1,000,000 

1,500,000 
2,000,000 


3.50 

3.477 

3.465 

3.444 

3.424 

3.410 
3.397 
3.386 
3.376 
3.352 

3.33 

3.294 

3.251 

3.222 

3.177 

3.137 
3.105 
3.026 
3.019 
2.933 

2.830 
2.761 
2.639 
2.525 
2.419 

2.252 
2.151 
2.061 
1.971 
1.837 

1.833 
1.523 


4.00 

3.973 

3.960 

3.936 

3.913 

3.897 
3.882 
3.869 
3.858 
3.831 

3.806 
3.764 
3.715 
3.683 
3.642 

3.586 
3.548 
3.470 
3.451 
3.353 

3.235 
3.155 
3.016 

2.885 
2.765 

2.572 
2.458 
2.356 
2.253 
2.099 

1.866 
1.739 


4.50 

4.470 

4.455 

4.428 

4.402 

4.384 
4.368 
4.353 
4.341 
4.310 

4.282 
4.234 
4.179 
4.143 
4.097 

4.034 
3.992 
3.904 
3.882 
3.772 

3.639 
3.550 
3.393 
3.246 
3.111 

2.895 
2.766 
2.650 
2.534 
2.362 

2.099 
1.957 


5.00 

4.966 

4.95 

4.92 

4.891 

4.871 
4.853 
4.836 
4.823 
4.788 

4.757 
4.705 
4.644 
4.603 
4.552 

4.482 
4.435 
4.338 
4.314 
4.191 

4.043 
3.944 
3.770 
3.606 
3.457 

3.216 
3.073 
2.944 
2.816 
2.624 

2.333 
2.175 


INDIVIDUAL    INCOME    TAX 


137 


YIELD  OF  TAXABLE  BONDS 


5M's 

6's 

6K's 

7's 

Yield  of 

Liberty  4's 

% 

Taxable 
Income 

5.50 

6.00 

6.50 

7.00 

4.00 

$2,000 

5.463 

5.959 

6.457 

6.953 

4.00 

3,000 

5.445 

5.940 

6.435 

6.93 

4.00 

4,000 

5.412 

5.904 

6.396 

6.888 

4.00 

5,000 

5.380 

5.869 

6.359 

6.848 

3.993 

6,000 

5.359 

5.846 

6.333 

6.820 

3.988 

7,000 

5.338 

5.824 

6.309 

6.794 

3.982 

8,000 

5.320 

5.804 

6.287 

6.771 

3.975 

9,000 

5.305 

5.787 

6.269 

6.752 

3.97 

10,000 

5.267 

5.746 

6.224 

6.703 

3.952 

12,500 

5.233 

»     5.708 

6.184 

6.659 

3.933 

15,000 

5.175 

5.646 

6.116 

6.587 

3.9 

20,000 

5.108 

5.573 

6.037 

6.502 

3.856 

25,000 

5.064 

5.524 

5.984 

6.445 

3.827 

30,000 

5.008 

5.463 

5.918 

6.374 

3.79 

40,000 

4.931 

5.397 

5.827 

6.275 

3.736 

50,000 

4.872 

5.322 

5.766 

6.208 

3.7 

60,000 

4,772 

5.206 

5.639 

6.073 

3.624 

75,000 

4.745 

5.177 

5.608 

6.039 

3.605 

80,000 

4.610 

5.029 

5.449 

5.867 

3.508 

100,000 

4.447 

4.852 

5.256 

5.660 

3.39 

1  125,000 

4.338 

4.733 

5.127 

5.522 

3.31 

150,000 

4.146 

4.524 

4.902 

5.278 

3.174 

200,000 

3.967 

4.328 

4.688 

5.049 

3.043 

250,000 

3.803 

4.148 

4.494 

4.840 

2.922 

300,000 

3.538 

3.860 

4.181 

4.503 

2.732 

400,000 

3.381 

3.688 

3.995 

4.303 

2.617 

500,000 

3.237 

3.532 

3.826 

4.120 

2.515 

600,000 

3.098 

3.379 

3.661 

3.942 

2.412 

750,000 

2.886 

3.149 

3.411 

3.674 

2.259 

1,000,000 

2.566 

2.799 

3.032 

3.25 

2.026 

1,500,000 

2.392 

2.609 

2.827 

3.044 

1.9 

2,000,000 

CHAPTER  VI 

INDIVIDUAL  INCOME  TAX 

RETURNS  AND   COMPUTATION  OF  TAX 

RETURNS 

Filing  of  returns. — Every  individual  required  by  law 
to  file  a  return  must  file  a  return  of  his  or  her  net  in- 
come for  the  calendar  year  on  or  before  March  1  of 
the  following  year.  The  time  for  filing  the  return  for 
1917,  however,  has  been  extended  to  April  1,  1918. 

The  return  must  be  made  out  and  sworn  to  in  person 
by  the  individual  from  whom  the  return  is  due,  unless 
he  is  unable  to  do  so  by  reason  of  minority,  sickness, 
absence,  or  insanity.  In  such  cases  the  return  should 
be  made  by  the  individual's  guardian  or  agent. 

As  is  explained  in  a  later  chapter  on  "Fiduciaries," 
fiduciaries  need  report  only  the  income  of  the  persons, 
trusts,  or  estates  for  whom  they  act  as  fiduciaries,  un- 
less they  are  legally  authorized  to  act  for  the  bene- 
ficiaries as  agents  or  attorneys.  In  fact,  a  fiduciary  is 
under  no  obligation  to  make  out  the  personal  return  for 
the  beneficiary  unless  the  beneficiary  is  a  non-resident 
alien  or  incompetent.  The  liability  of  the  fiduciary  to 
make  a  return  applies  only  with  respect  to  such  income 
as  accrues  and  is  payable  through  himself,  and  not  to 
the  income  of  the  beneficiary  derived  from  other  sources. 

Extensions  of  time  for  filing  returns. — The  collector  of 
the  district  may,  in  cases  of  sickness  or  absence,  grant 
an  extension  of  time,  not  exceeding  30  days  from  the 
time  the  return  would  otherwise  be  due. 

138 


INDIVIDUAL    INCOME    TAX  139 

The  Commissioner  of  Internal  Bevemie  has  authority 
to  grant  a  further  extension  of  time  for  any  adequate 
reason.  Under  this  provision  of  the  law  an  extension 
of  time  has  been  granted  for  the  filing  of  returns  for 
the  year  1916  and  subsequent  years  to  non-resident 
alien  individuals  and  corporations  and  to  American 
citizens  residing  abroad.  These  individuals  will  be 
given,  by  the  provisions  of  T.  D.  2581,  until  90  days 
after  the  proclamation  of  the  President  of  the  United 
States  announcing  the  end  of  the  war  with  Germany. 
This  extension  applies  only  in  those  cases  where  the 
delay  was  caused  by  war  conditions.  In  all  such  cases 
there  must  be  attached  to  the  return,  when  made,  an 
affidavit  stating  the  cause  or  causes  of  delay  in  filing 
returns  of  income  within  the  time  required  by  law.  If 
this  affidavit  shows  that  the  failure  to  file  the  return  in 
time  was  excusable,  no  penalty  will  be  incurred. 

In  cases  where  a  complete  return  cannot  be  filed 
within  the  time  prescribed  by  law  or  within  the  exten- 
sion period,  a  tentative  return  should  be  filed  within 
the  time  in  order  to  avoid  any  penalty  which  would 
otherwise  be  incurred  (see  page  22).  Following  this 
tentative  return,  a  true  and  accurate  return  should  be 
filed  just  as  soon  as  the  data  to  be  incorporated  in  the 
complete  return  are  available. 

Where  return  is  to  be  filed. — The  return  should  be  filed 
with  the  collector  of  internal  revenue  for  the  district1 
in  which  the  individual  has  his  legal  residence  or  place 
of  business.  If  the  individual  has  no  legal  residence 
or  place  of  business  in  the  United  States  the  return 
must  be  filed  with  the  collector  of  internal  revenue  at 
Baltimore,  Md.  A  fiduciary  should  file  a  return  with 
the  collector  of  internal  revenue  for  the  district  in 
which  he  resides. 

The  location  of  an  individual's  legal  residence  may  be 
subject  to  dispute.     As  far  as  the  income  tax  is  con- 

i  See  Collection  Districts,  p.  609. 


140  INCOME    AND    FEDERAL    TAX    REPORTS 

cerned,  it  makes  no  difference  in  what  district  the  re- 
turn is  filed,  except  that  for  administrative  purposes 
the  Department  prefers  that  it  be  filed  in  the  district 
in  which  the  individual  resides. 

The  filing  of  a  return  in  a  certain  district  would  be 
an  admission  on  the  part  of  the  individual  that  his 
legal  residence  was  within  that  district,  which  admis- 
sion might  be  important  as  far  as  State  inheritance  and 
personal  property  taxes  are  concerned. 

Form  of  return. — The  return  must  be  made  out  on  the 
form  furnished  by  the  collector  of  internal  revenue,  and 
must  be  signed  and  sworn  to  before  an  officer  author- 
ized by  law  to  administer  oaths. 

The  forms  of  returns  provided  for  the  use  of  indi- 
viduals are  Form  1040  A,  to  be  used  by  individuals  hav- 
ing a  net  income  not  in  excess  of  $3,000,  and  Form 
1040,  to  be  used  by  individuals  having  a  net  income  in 
excess  of  $3,000.  The  information  required  on  each  of 
the  forms  is  discussed  in  the  preceding  chapters;  the 
preparation  and  execution  of  the  form  is  discussed  on 
the  following  pages. 

FORM   1040  A 

When  Form  1040  A  is  to  be  used. — This  form  is  de- 
signed to  be  used  by  individuals  whose  income  is  sub- 
ject only  to  the  2  per  cent  tax  imposed  by  the  War 
Eevenue  Act  of  October  3,  1917. 

The  maximum  amount  of  income  for  which  this  form 
may  be  used  in  various  cases  is  as  follows : 

Income  not  exceeding 

Single— not  head  of  family $3,000 

Married  or  head  of  family 4,000 

Married  or  head  of  family,  which  includes  one 

dependent  child 4,200 

two  dependent  children 4,400 

three  dependent  children  4,600 

four  dependent  children 4,800 

five  or  more  dependent  children 5,000 


INDIVIDUAL    INCOME    TAX  141 

In  order  to  determine  whether  or  not  a  return  should 
be  filed,  or  whether  or  not  this  form  may  be  used,  the 
amount  of  net  income  should  be  calculated  on  page  3 
and  totaled  on  line  H  of  the  Form.  This  amount  is 
then  forwarded  to  page  4  and  to  it  is  added  (a)  the 
amount  of  dividends  received  and  (b)  the  amount  of 
interest  on  tax-free  covenant  bonds.1 

Interest  on  bonds  of  the  second  Liberty  Loan,  War 
Savings  certificates  and  Treasury  certificates  of  in- 
debtedness, are  subject  to  the  super-tax  on  the  interest 
from  bonds  and  certificates  in  excess  of  a  total  of  $5,000 
par  value.  The  amount  of  such  interest  on  the  amount 
of  bonds  and  certificates  held  by  one  individual  in  ex- 
cess of  $5,000  should  also  be  added  in  arriving  at  this 
total  income.  The  officials  in  making  up  this  form  have 
apparently  overlooked  the  possibility  that  a  person  with 
such  an  income,  as  shown  on  line  13,  of  less  than 
$5,000  may  be  the  owner  of  more  than  $5,000  worth 
of  bonds  of  the  second  Liberty  Loan  and  certificates 
mentioned  above. 

From  the  resulting  figure  of  total  income  there 
should  be  deducted  the  amount  of  contributions.2  The 
amount  deducted  is  limited  to  15  per  cent  of  the  total 
income  shown  on  the  line  above.  The  resulting  figure 
is  the  total  net  income.  If  this  figure  is  in  excess  of 
the  amount  stated  as  a  maximum  on  the  preceding  page, 
the  large  form,  1040,  should  be  used. 

No  individual  whose  net  income  for  the  calendar  year 
has  been  less  than  $1,000  need  file  a  return,3  and  no  re- 
turn is  required  of  man  or  wife,  or  both,  living  to- 
gether, if  their  combined  net  income  is  less  than  $2,000, 
including  income  of  minor  children. 

Any  other  citizen  or  resident  will  not  be  required  to 
file  a  return  if  his  total  net  income  is  less  than  $1,000. 

i  See  Chapter  on  Withholding,  etc.,  at  the  Source,  p.  266. 

2  See  page  113. 

3  This  refers  to  a  return  of  taxable  income,  and  not  to  the  report  of  in- 
formation at  the  source.     See  "Information  at  the  Source,"  pp.  277-280. 


142  INCOME    AND    FEDERAL    TAX    REPORTS 

The  preparation  of  Form  1040  A. — Page  3  of  the  form 
should  be  filled  out  first.  This  form  does  not  have  the 
separation  of  total  income  and  total  deductions  provided 
in  the  old  forms.  Instead,  income  is  divided  into  five 
subdivisions,  and  certain  deductions  are  allowed  directly 
against  a  certain  class  of  income.  In  addition,  a  sec- 
tion is  provided  for  general  deductions,  not  applicable 
to  any  specific  class  of  income. 

Section  A  includes  income  from  salaries,  wages,  com- 
missions, bonuses  and  pensions.  These  items  are  dis- 
cussed on  pp.  48  to  52. 

Division  B  includes  income  from  business,  farm,  or 
profession. 

This  section  requires  the  gross  receipts  from  the  sale 
of  farm  products,  merchandise,  or  business  or  profes- 
sional services  to  be  reported.  (See  pp.  52-59.)  The 
deductions  against  these  receipts  are: 

1.  Labor.  Salary  paid  by  the  person  making  the  re- 
turn to  himself  or  members  of  his  dependent  family 
should  not  be  deducted  here  unless  it  is  included  as  in- 
come in  Section  A.  But  the  salary  paid  a  member  of 
the  family  (other  than  wife)  may  be  deducted  here  and 
not  be  included  as  income  elsewhere  in  the  return,  if 
such  person  is  21  years  of  age  or  over  and  not  actually 
a  dependent.  In  such  case  that  person  should  file  a 
personal  return  of  net  income  in  excess  of  $1,000  or 
$2,000,  as  the  case  may  be. 

2.  Materials  and  supplies.  The  instruction  as  to  in- 
ventories is,  that  increases  in  inventories  should  be 
added  to  the  gross  receipts,  and  decreases  in  inven- 
tories should  be  added  to  the  amount  of  expenses.  On 
pages  52-56  it  is  pointed  out  that  the  proper  method  is 
to  deduct  the  inventory  increase  or  add  the  inventory 
decrease  to  the  purchases  of  materials.  The  result  in 
either  case  is  the  same. 

3.  Eent.  The  deduction  of  rent  in  cases  where  a 
building  is  used  both  for  business  and  as  a  dwelling 


INDIVIDUAL    INCOME    TAX  143 

and  other  questions  arising  under  "Rent"  are  discussed 
on  page  104. 

4.  Merchandise  or  live  stock  bought  for  sale.  The 
comment  as  to  inventories  of  materials  and  supplies  ap- 
plies to  merchandise  also.  The  instructions  do  not 
state  whether  inventories  should  be  valued  at  cost  or 
market  value.  This  question  is  still  open,  and  a  dis- 
cussion of  it  will  be  found  on  pages  54  and  55. 

5.  Wear  and  tear  and  repairs.  This  includes  not 
only  the  amount  paid  out  for  repairs  but  also  an  allow- 
ance for  depreciation.  For  a  full  discussion,  see  pp. 
122-124. 

6.  Losses  by  fire,  storm,  other  casualties,  or  theft. 
Losses  from  bad  debts  should  apparently  be  included 
under  "Other  expenses." 

7.  Other  expenses.  In  the  instructions  this  is  called: 
"Other  expenses  and  losses."  Losses  from  bad  debts 
should  be  included  under  this  heading.  Losses  on  bad 
debts  arising  from  transactions  not  connected  with  the 
individual's  business  should  be  deducted  under  Division 
G-,  as  a  general  deduction. 

Items  1  to  7  should  be  totaled  and  deducted  from  the 
amount  of  gross  receipts  reported.  This  will  give  the 
net  income  from  business,  farm  or  profession. 

In  order  to  support  the  item  of  wear,  tear  and  re- 
pairs, a  statement  is  required  of  the  cost  of  the  business 
or  farm  property;  of  the  construction  of  the  build- 
ings; and  the  cost  of  the  business  equipment. 

Division  C.  Profit  from  sale  of  land,  buildings,  and 
other  property,  real  or  personal.  As  to  each  item  of 
property  sold  there  is  required  a  statement  of 

1.  The  kind  of  property,  that  is,  "farm,"  "apartment 
house,"  "dwelling,"  "mine,"  etc. 

2.  The  year  in  which  the  property  was  acquired. 

3.  The  sale  price  of  the  property. 

4.  The  cost  of  the  property,  or  the  fair  market 
value,  as  of  March  1,  1913,  if  it  was  acquired  prior  to 


144  INCOME    AND    FEDERAL    TAX    REPORTS 

March  1,  1913.  Depreciation  or  depletion  previously 
deducted  from  income  must  be  deducted  from  the  cost 
Other  factors  affecting  the  profit  are  discussed  in  the 
chapter  on  Individual  Income,  pp.  59-66. 

Division  D.  Income  from  rents  and  royalties  (pp. 
66-67  and  76-77). — The  form  requires  as  to  each  piece 
of  property  a  statement  of: 

1.  The  kind  of  property,  including  its  construction. 

2.  The  cost  of  the  building.  This  should  be  only  the 
cost  of  the  property  on  which  an  allowance  for  depre- 
ciation is  claimed. 

3.  The  cash  or  equivalent  received  as  rent  or  royalty. 

4.  The  amount  of  wear,  tear  and  repairs.  In  the 
case  of  oil  and  gas  wells,  'mines,  etc.,  a  reasonable 
allowance  may  be  deducted  for  depletion.  See  chapter 
on  Corporation  Income,  Deductions. 

5.  Other  expenses  and  losses. 

The  amount  received  as  rent  or  royalty  (3),  less  the 
sum  of  the  wear,  tear  and  repairs  (4),  and  expenses 
(5),  will  be  the  net  income  from  rents  and  royalties. 

Division  E.  Other  income. — All  income  not  reported 
under  the  previous  headings  must  be  reported  here 
with  the  exception  of: 

1.  Dividends  received  from  corporations  which  are 
themselves  subject  to  the  income  tax.     (See  p.  78.) 

2.  Interest  received  on  bonds  on  which  the  issuing 
corporation  has  agreed  to  pay  the  tax.  (See  chapter 
on  Withholding,  Deduction  and  Information  at  the 
Source.) 

3.  Interest  received  on  bonds  of  the  United  States 
or  its  possessions,  or  any  State  or  any  political  sub- 
division of  a  State.     (See  pp.  41  and  42.) 

4.  Interest  on  federal  farm  loans.     (See  p.  39.) 

5.  Proceeds  of  life  insurance  policies  paid  by  the  in- 
sured and  premiums  returned  by  life  insurance  com- 
panies.    (See  p.  40.) 

6.  Principal  only  of  gifts  and  legacies.     (See  p.  41.) 


INDIVIDUAL    INCOME    TAX  145 

The  first  two  items  would  be  subject  to  the  super- tax 
if  the  income  were  in  excess  of  $5,000,  and  therefore 
must  be  shown  on  page  4  of  the  return  to  make  sure 
that  the  net  income  would  not  exceed  $5,000  if  these 
were  included. 

The  income  from  partnership,  excluding  any  income 
from  items  1,  3,  4,  5,  6  listed  above,  should  also  be  in- 
cluded. (See  pp.  56  and  71  to  75.)  Interest  on  tax- 
free  covenant  bonds  received  through  a  partnership 
must  be  included  as  income.  No  withholding  is  au- 
thorized against  partnerships  and  therefore  the  issuing 
corporation  cannot  pay  the  tax  at  the  source,  in  accord- 
ance with  its  contract.  (See  chapter  on  "Withhold- 
ing, Deduction,  and  Information  at  the  Source.") 

The  instructions  do  not  mention  the  fact  that  where  a 
partnership  determines  its  profits  on  the  basis  of  a  fis- 
cal year  the  individual  partners  are  taxed  on  their 
shares  of  the  profits  at  the  rates  in  effect  for  the  re- 
spective years  in  which  such  profits  were  earned.  In- 
dividuals who  received  income  from  a  partnership  clos- 
ing its  books  as  of  a  fiscal  year  should  apportion  such 
income  between  1916  and  1917,  as  explained  in  the  chap- 
ter on  Income  from  Partnerships  (pp.  72  to  73).  The 
entire  amount  should  be  reported  under  Column  1  as 
"Cash  received";  the  amount  determined  as  earned  in 
1916  under  Column  2  as  expenses  paid,  and  the  differ- 
ence will  be  the  amount  taxable  as  income  for  1917. 

Income  on  which  the  tax  has  not  been  paid,  received 
from  fiduciaries,  excluding  any  income  from  items  1  to 
6  listed  on  the  preceding  page  should  also  be  reported. 
(See  Chapter  on  Fiduciaries.) 

The  net  income  as  shown  under  headings  A  to  E  in- 
clusive should  be  totaled,  giving  the  total  net  income. 
If  a  loss  is  reported  under  Division  B,  D,  or  E  it  may 
be  shown  as  a  general  deduction  under  Division  Gr.  If 
a  loss  is  shown  under  Division  C,  it  will  be  allowed  as 
a  deduction  only  if  the  transactions  out  of  which  the 


146        INCOME    AND    FEDERAL    TAX    REPORTS 

loss  resulted  were  connected  with  the  individual's  busi- 
ness. (See  p.  113,  Deductions.)  If  this  deduction  is 
claimed  a  statement  must  be  attached  to  the  return  ex- 
plaining how  the  transactions  were  connected  with  the 
individual  business. 

Division  G.  General  deductions. — Under  "Interest 
paid,"  all  interest  payments  should  be  deducted,  except 
interest  paid  on  obligations  incurred  in  the  purchase 
of  tax-exempt  securities,  including  Liberty  Bonds  of 
the  first  and  second  loan. 

Taxes  (see  p.  110),  losses  on  personal  loans  and  on 
other  bad  debts  that  are  not  connected  with  the  indi- 
vidual's business  (see  p.  120)  may  also  be  deducted. 
Charitable  contributions  made  should  not  be  included 
in  this  section. 

F. — The  net  income  will  be  the  difference  between  the 
total  net  income  and  the  general  deductions.  From 
this  figure  may  be  deducted  contributions  made  to  relig- 
ious, charitable  and  educational  organizations  to  an 
amount  not  in  excess  of  15  per  cent  of  the  total  net 
income  (including  dividends  and  interest  from  tax-free 
bonds),  as  previously  explained.  (See  p.  113,  Deduc- 
tions.) 

From  this  "balance  of  net  income,"  as  it  is  called  on 
the  form,  is  to  be  deducted  the  personal  exemption  al- 
lowed by  the  law,  which  is  explained  in  the  preceding 
chapter  on  Rate  of  Tax.  The  resulting  figure  is  the 
income  subject  to  the  2  per  cent  tax  imposed  by  the  act 
of  October  3,  1917.  The  tax  due  will  be  2  per  cent  of 
this  figure. 

Additional  information  required. — In  addition  to  the 
statement  of  his  net  income,  the  taxpayer  must  also  state 
whether  or  not  he  filed  a  return  for  1916,  and  if  so, 
what  address  he  gave  and  to  what  collector's  office  he 
sent  the  return.  He  must  also  support  his  claim  for 
personal  exemption  by  stating  his  status  as  of  Decem- 
ber 31,  1917-    He  must  also  state  whether  or  not  a 


INDIVIDUAL    INCOME    TAX  147 

separate  return  was  made  by  his  wife,  or  dependent 
child,  and  if  so,  the  name  under  which  such  return  was 
filed.  He  must  also  give  any  other  address  which  he 
furnished  to  any  person,  firm  or  corporation  from 
whom  he  received  $800  or  more  income  during  1917. 

The  return  must  be  signed  by  the  taxpayer  or  his 
agent  and  properly  sworn  to.  If  signed  by  an  agent, 
the  reason  why  the  return  is  made  by  the  agent  must 
be  given. 

Special  provision  has  been  made  for  the  verification 
of  returns  of  individuals  in  the  naval  and  military 
forces  of  the  United  States.  The  verification  of  the  re- 
turn by  any  officers  authorized  to  administer  oaths  for 
military  or  naval  justice  will  be  accepted  by  the  Treas- 
ury Department. 

FORM  1040 

The  preparation  of  Form  1040. — Form  1040  is  to  be 
used  by  individuals  having  a  net  income  in  excess  of 
$3,000,  although  as  previously  stated,  Form  1040  A  may, 
under  certain  conditions,  be  used  by  individuals  having 
a  net  income  in  excess  of  $3,000,  but  not  in  excess  of 
$5,000. 

The  taxpayer  is  required  to  report  his  net  income 
under  one  or  more  of  the  headings  shown  in  the  return. 

Net  income  is  grouped  into  eight  divisions,  a  short 
discussion  of  the  items  to  be  reported  under  heading 
follows : 

Division  A.  Income  from  salaries,  wages,  commis 
sions,  bonuses,  directors'  fees,  pensions  and  from  pro- 
fessions (see  pp.  48-52). — Income  resulting  from  the 
employment  of  other  than  nominal  capital  should  not 
be  reported  under  this  heading  but  should  be  shown 
under  Division  B.  A  definition  of  nominal  capital  will 
be  found  in  the  Chapter  on  Excess  Profits  Tax.  The 
income  reported  under  this  heading  is  subject  also  to 
a  tax  of  8  per  cent  on  the  amount  in  excess  of  $6,000 


148  INCOME    AND    FEDERAL    TAX    REPORTS 

under  the  War  Excess  Profits  Tax.  The  amount  of  this 
tax  (Excess  Profits)  will  be  credited  against  the  net 
income  before  computing  the  income  tax.  The  income 
to  be  reported  should  be  that  income  as  is  explained 
under  "Salaries,  Wages,  Commissions,  etc."  A  discus- 
sion of  the  various  items  which  constitute  allowable 
deductions  against  this  income  will  be  found  in  the 
chapter  on  "Individual  Income  Tax  Deductions — Neces- 
sary Expenses."  The  nature  of  the  deductions  should 
be  described  briefly  in  the  space  provided  on  the  form. 

Salary  or  commission  or  other  income  amounting  to 
$800  or  more  received  from  one  person,  firm  or  cor- 
poration should  be  reported  separately,  together  with 
the  name  of  the  person,  firm  or  corporation  paying- 
same. 

Division  B.  Income  from  business,  including  farm- 
ing (see  pp.  52-59). — The  form  provides  a  clear  method 
of  showing  the  net  income  from  business.  A  profit  and 
loss  statement  taken  from  the  books  of  the  individual 
may  be  attached  to  the  return  and  the  net  income 
shown  by  the  statement  entered  as  net  income  from 
business. 

Merchandise  and  securities  may  be  inventoried  either 
at  cost  or  at  cost  or  market,  whichever  is  lower. 
A  discussion  of  the  advisability  of  inventorying  mer- 
chandise at  market  price  will  be  found  on  pages  54 
and  55. 

Division  C.  Profits  from  sale  of  real  estate,  bonds 
and  other  securities  (see  pp.  59-66). — In  determining 
the  cost  of  real  estate  sold  such  incidental  expenses  of 
purchasing  the  property  as  have  not  been  deducted  in 
previous  returns  may  be  added  to  the  original  cost,  as 
may  also  the  amount  of  taxes  assessed  against  the  prop- 
erty for  local  benefits.  The  amount  of  depreciation 
deducted  from  income  on  previous  returns  should  be 
added  to  the  sales  price. 

If  such  transactions  show  a  net  loss,  the  loss  will  not 


INDIVIDUAL    INCOME    TAX  149 

be  permitted  as  a  deduction  unless  the  transactions 
were  connected  with  the  individual's  regular  business. 
A  discussion  of  the  meaning  of  "regular  business"  will 
be  found  in  the  chapter  on  "Individual  Income  Tax — 
Deductions." 

Division  D.  Income  from  rents  and  royalties. — The 
amount  received  as  rents  (see  pp.  66-67)  or  royalties 
(see  pp.  76-77)  should  be  reported  here.  The  allow- 
able deductions  include  repairs,  depreciation,  interest, 
taxes,  and  other  expenses.  See  Chapter  on  "Individual 
Income  Tax — Deductions." 

Division  E.  Interest  on  bonds  and  other  obligations 
of  the  United  States  issued  after  September  1,  1917. — 
There  should  be  reported  only  the  interest  received  on 
the  amount  of  bonds  of  the  second  Liberty  Loan,  War 
Savings  Certificates  and  Treasury  Certificates  of  In- 
debtedness held  by  one  individual  in  excess  of  a  total 
of  $5,000  of  par  value.  From  this  there  may  be  de- 
ducted that  portion  of  the  interest  paid  on  indebted- 
ness incurred  in  the  purchase  of  such  bonds  or  certifi- 
cates as  the  amount  of  such  obligations  held  in  excess 
of  $5,000  is  to  the  total  amount  held.  To  illustrate:  A 
purchased  $10,000  worth  of  Liberty  4's  on  November  15, 
1917.  In  order  to  purchase  them  he  borrowed  $10,000 
from  his  bank  at  5  per  cent.  He  sold  his  bonds  Decem- 
ber 31,  1917,  at  par  and  accrued  interest  and  with  the 
proceeds  took  up  his  loan  at  the  bank.  He  would  re- 
port as  follows: 

1.  Amount  of  bonds. . $10,000.00 

2.  Amount  of  interest  received  on  amount  in 

excess  of  $5,000 25.00 

3.  Indebtedness    incurred    for    the    purchase 

of  bonds  or  certificates 10,000.00 

4.  Interest   paid    on   proportionate    part    of 

indebtedness  (total  interest  paid  $62.50), 

one-half  of  $62.50 31.25 

5.  Excess  of  interest  paid 6.25 


150  INCOME   AND    FEDERAL    TAX   REPORTS 

This  excess  of  interest  paid  should  be  included  among 
other  deductions  in  Division  J  of  the  form,  which  will 
exclude  such  excess  from  the  super-tax. 

This  excess  interest  paid  is  not  a  proper  deduction 
from  the  normal  tax  and  therefore  must  be  added  to 
the  amount  of  income,  subject  to  the  normal  tax,  as 
provided  on  line  24. 

Where  the  amount  of  interest  received  exceeds  the 
amount  of  interest  paid  the  excess  amount  received  is 
included  as  income,  but  inasmuch  as  the  interest  on 
these  bonds  is  subject  only  to  the  super-tax,  the  excess 
amount  received  must  be  deducted  on  line  19  from  the 
amount  of  income  subject  to  the  normal  tax. 

Division  F.  Dividends  on  stock  of  corporations  or- 
ganized or  operating  in  the  United  States  and  subject 
to  the  income  tax. — To  be  included  in  this  division  the 
dividends  must  be  on  stocks  of  corporations  which  are 
subject  to  the  income  tax  on  their  entire  net  income. 
As  hereinbefore  explained,  dividends  on  stocks  of  for- 
eign corporations  transacting  part  of  their  business  in 
the  United  States  and  therefore  subject  to  tax  on  part 
of  their  net  income  should  be  included  under  "Other 
Income." 

Dividends,  as  previously  explained  (see  pp.  82-88), 
are  taxed  at  the  rates  in  effect  for  the  years  in  which 
the  surplus  out  of  which  they  are  paid  was  accumu- 
lated. Dividends  should  therefore  be  separated  accord- 
ing to  the  year  accumulated.  The  amount  accumulated 
prior  to  1913  need  not  be  shown.  The  amounts  in  the 
years  1913,  1915,  1916,  1917  should  be  shown  separately 
on  the  form,  but  only  the  amount  accumulated  in  1917 
is  included  in  the  income  subject  to  the  taxes  in  effect 
for  1917.  The  tax  on  the  amount  accumulated  in  the 
previous  years  must  be  made  separately  and  the  amount 
of  tax  entered  on  line  37.  The  method  used  in  this  cal- 
culation is  illustrated  in  the  paragraphs  on  Computation 
of  Tax,  p.  155. 


INDIVIDUAL    INCOME    TAX  151 

Division  G.  Interest  on  tax-free  covenant  bonds  on 
which  one  normal  tax  of  2  per  cent  was  withheld  at  the 
source, — Interest  on  bonds  containing  a  tax-free  cove- 
nant and  on  which  no  exemption  has  been  claimed 
should  be  reported  here.  If  exemption  has  been  claimed 
and  no  tax  paid  at  the  source  the  interest  should  be  re- 
ported under  "Other  Income,"  Division  H. 

Division  H.  Other  income.  All  forms  of  income, 
with  the  exception  of  tax-exempt  income,  which  have 
not  been  included  elsewhere,  should  be  reported  under 
this  heading. 

Income  from  partnerships  should  be  included,,  except 
that  part  of  the  profits  which  was  originally  derived 
from  the  following  sources,  which  should  be  excluded: 

1.  Interest  on  obligations  of  the  United  States  issued 
since  September  1,  1917.  This  should  be  shown  in  Di- 
vision E  to  the  extent  provided  under  that  heading. 

2.  Dividends  on  stocks.  This  should  be  entered  in 
Division  F. 

3.  Interest  on  tax-exempt  securities.  These  need  not 
be  shown  on  the  return  at  all. 

Where  the  fiscal  year  of  the  partnership  differs  from 
the  calendar  year  the  income  should  be  apportioned  as 
between  1916  and  1917.  That  portion  which  is  deter- 
mined to  be  earned  in  1917  should  be  extended  in  the 
net  income  column.  The  portion  which  is  applied  to 
1916  should  be  entered  in  the  deduction  column.  The 
calculation  of  the  tax  upon  this  amount  at  the  rates  in 
effect  for  1916  is  to  be  made  separately  and  the  amount 
of  the  tax  is  to  be  added  to  the  total  tax  due.  See 
p.  72. 

Income  from  fiduciaries  should  be  entered  here,  ex- 
cepting income  from  the  three  sources  above,  and  also 
excepting  interest  on  tax-free  covenant  bonds  on  which 
no  exemption  has  been  claimed.  This  interest  should 
be  included  in  Division  G. 

Division  I.     Total  net  income  from  all  sources. — The 


152  INCOME   AND    FEDERAL    TAX   REPORTS 

total  of  divisions  A  to  H  inclusive  will  give  the  total 
net  income  from  all  sources.  From  this  may  be  de- 
ducted the  "general  deductions." 

Division  J.  General  deductions. — Under  this  heading 
will  be  included  interest  on  personal  indebtedness,  taxes 
paid  on  dwelling,  the  excess  interest  paid  as  reported 
under  Division  E,  the  loss,  if  any,  reported  under  B, 
D  or  H,  and  the  loss,  if  any,  provided  under  Division 
C,  if  such  transactions  formed  part  of  the  individual's 
business. 

Division  K.  Total  net  income. — This  is  the  differ- 
ence between  I  and  J. 

Division  L  provides  for  the  deduction  from  K  of  the 
amount  of  excess  profit  taxes,  if  any,  for  1917.  The 
resulting  figure  is  M. 

Division  N.  Contributions  to  charitable  organiza- 
tions.— Provides  for  the  deduction  from  M  of  contribu- 
tions to  an  amount  not  in  excess  of  15  per  cent  of  item 
M  (see  Individual  Income  Tax — Deductions).  These 
contributions  must  be  listed.  The  final  figure  M  minus 
N  is  the  net  income  (Item  0)  on  which  the  income  tax, 
normal  tax  and  super-tax,  is  to  be  calculated. 

In  the  instructions  on  Form  1040,  Revised,  contri- 
butions cannot  be  over  15  per  cent  of  item  M.  Item  M, 
it  appears,  includes  all  income  received  with  the  ex- 
ception of  dividends  received  in  1917  paid  out  of  cor- 
porations' accumulated  profits  earned  in  1913,  1914, 
1915  and  1916.  Inasmuch  as  the  income  which  may  be 
reported  under  these  four  years  is  not  added  to  the 
total  in  computing  the  amount  to  be  extended  on  line 
M  of  page  4,  the  statement  with  reference  to  the  total 
deductions  on  page  4  of  Form  1040,  that  the  contribu- 
tions cannot  exceed  15  per  cent  of  item  M,  seems 
erroneous.  It  appears  that  the  intent  of  Congress 
was  to  allow  15  per  cent  of  the  total  taxable  income  of 
an  individual  and  which  should  also  include  the  divi- 
dends received  in  1917  from  corporations'  accumulated 


INDIVIDUAL    INCOME    TAX  153 

profit  earned  in  years  prior  to  1917.  By  following 
strictly  the  instructions  on  Form  1040,  it  appears  that 
an  individual  will  not  be  allowed  full  deductions  of 
contributions  which  should  be  allowed  them. 

Before  computing  the  normal  tax  there  should  be  de- 
ducted, as  provided  for  by  lines  19,  20,  and  21  and  22, 
those  items  which  are  exempt  from  the  normal  tax,  as 
follows : 

1.  Excess  of  interest  received  over  interest  paid  on 
obligations  incurred  to  purchase  obligations  of  the 
United  States  issued  since  September  1,  1917  (Item  E), 

2.  Dividends  (Item  F)  paid  out  of  1917  earnings,  and 

3.  The  personal  exemption  (explained  in  Chapter  on 
"Rate  of  Tax"). 

To  the  remaining  balance  (line  23)  there  must  be 
added  any  items  which  are  subject  to  the  normal  tax 
but  not  to  the  super- tax.    The  only  item  in  this  class  is : 

1.  Excess  of  interest  paid  on  indebtedness  incurred 
for  purchase,  over  interest  received,  on  obligations  of 
United  States  issued  since  September  1,  1917  (line  24), 
as  shown  under  Division  E. 

The  resulting  amount  (line  25)  is  subject  to  the  2 
per  cent  normal  tax  imposed  by  the  act  of  October  3, 
1917.  Deducting  $2,000  (line  26),  which  is  the  differ- 
ence between  the  personal  exemptions  allowed  by  the 
1916  and  1917  laws,  we  have  the  income  subject  to  the 
2  per  cent  tax  imposed  by  the  act  of  September  8,  1916 
(line  27). 

Calculation  of  super-tax. — The  super-tax  or  surtax  will 
be  calculated  on  Item  O,  "Net  income  on  which  income 
tax  is  to  be  calculated,"  according  to  the  table  on  page 
154. 

To  compute  the  amount  of  surtax  due  on  any  amount 
of  net  income  in  excess  of  $5,000,  first  find  in  Column  A 
the  largest  sum  which  is  less  than  the  amount  of  total 
net  income  reported  on  the  return,  Item  O,  then  find 
in  Column  E  the  corresponding  amount  of  total  surtax. 


154 


INCOME    AND    FEDERAL    TAX    REPORTS 


Amount  Sub- 

Amount of 

ject  to  Surtax 

Rate 

Amount  of 

Total  Sur- 

Net Income 

at  Rate  shown 

Surtax  at 

tax  on  Each 

in  Column  C 

Each  Rate 

Amount 

A 

B 

C 

D 

E 

$5,000 

$000 

o% 

$00 

$00 

7,500 

2,500 

1 

25 

25 

10,000 

2,500 

2 

50 

75 

12,500 

2,500 

3 

75 

150 

15,000 

2,500 

4 

100 

250 

20,000 

5,000 

5 

250 

500 

40,000 

20,000 

8 

1,000 

2,100 

60,000 

20,000 

12 

2,400 

4,500 

80,000 

20,000 

17 

2,400 

7,900 

100,000 

20,000 

22 

4,400 

12,300 

150,000 

50,000 

27 

13,500 

25,800 

200,000 

50,000 

31 

15,500 

41,300 

250,000 

50,000 

37 

18,500 

59,800 

300,000 

50,000 

42 

21,000 

80,800 

500,000 

200,000 

46 

92,000 

172,800 

750,000 

250,000 

50 

125,000 

297,800 

1,000,000 

250,000 

55 

137,500 

435,300 

1,500,000 

500,000 

61 

305,000 

740,300 

2,000,000 

500.000 

62 

310,000 

1,050,300 

Over  2,000,000 

63 

To  this  amount  add  an  amount  computed  as  follows: 
Subtract  from  the  net  income  (Item  O)  the  sum  first 
found  in  Column  A  and  multiply  the  remainder  by  the 
rate  shown  on  the  next  line  below  in  Column  C.  The 
sum  of  these  two  amounts  is  the  total  surtax  due. 

Calculation  of  total  tax. — Having  calculated  the  amount 
of  surtax,  the  amount  of  the  total  tax  due  will  be  ar- 
rived as  follows: 

1.  Normal  tax  of  2  per  cent  on  amount  shown  on  line 
25;  plus 

2.  Normal  tax  of  2  per  cent  on  amount  shown  on  line 
27;  giving 


INDIVIDUAL   INCOME    TAX  155 

3.  Total  normal  tax  (line  30) 

4.  Less  tax  withheld  on  tax-free  covenant  bonds  (2 
per  cent  on  net  total  of  item  G) ;  leaving 

5.  Balance  of  normal  tax  due;  plus 

6.  Surtax,  plus 

7.  Excess  profits  tax  of  8  per  cent  on  amount  of  in- 
come in  excess  of  $6,000  shown  under  Division  A. 

8.  Excess  profits  tax  on  income  from  business  with 
invested  capital  as  computed  on  excess  profits  tax  re- 
turn (Form  1001) ;  giving 

9.  Total  tax. 

10.  Additional  or  surtax  on  account  of  dividends  ac- 
cumulated in  1913,  1914,  1915,  or  1916,  and  partnership 
profits  earned  in  1916. 

11.  Total  tax  due. 

COMPUTATION  OF  INCOME  TAX  ON  INDIVIDUALS 

Example  illustrating  method. — The  following  example 
illustrates  the  method  of  computing  the  tax  where  cer- 
tain items  of  income  are  taxable  at  rates  other  than 
those  in  effect  for  1917: 

A,  a  married  person,  a  citizen  of  the  United  States, 
has  the  following  income: 

From  partnership  of  A,  B  &  Co $100,000 

Interest  on  bonds 5,000 

Stock  dividend  of  100  per  cent  on  1,000  shares 
(par  value  $100  per  share)  of  the  X,  Y ,  Z 

Cor<p 100,000 

Eegular  cash  dividends  on  the  same  stock ....       10,000 

Total  income  $215,000 

Regarding  his  income,  the  following  information  is 
available : 

Income  from  the  partnership  of  A,  B  &  Co.  This 
income  represents  a  one-half  share  of  the  profits  for 
the  fiscal  year  ended  March  31,  1917.  The  Excess 
Profits  tax  on  the  partnership  amounts  to  $20,000. 


156  INCOME    AND    FEDERAL    TAX   REPORTS 

Interest  on  bonds.  These  bonds  contain  a  tax-free 
covenant  clause,  and  the  tax  at  the  rate  of  2  per  cent 
has  been  paid  at  the  source. 

Stock  dividend.  This  dividend  was  paid  January  1, 
1917.  The  X,  Y,  Z  Corporation  distributed  a  surplus 
of  $10,000,000  by  declaring  a  dividend  of  100  per  cent 
on  its  outstanding  stock  of  $10,000,000. 

The  surplus  account  of  the  corporation  during  its 
growth  is  as  follows: 

Balance,  January  1,  1914 $3,000,000 

Added  for  the  year  1914 4,000,000 

Added  for  the  year  1915 3,000,000 

Added  for  the  year  1916 3,000,000 

Surplus,  January  1,  1917 , $13,000,000 

Eegular  cash  dividends.  These  dividends  are  the 
current  dividends  on  the  steck  of  the  X,  Y,  Z  Corpora- 
tion paid  out  of  1917  earnings. 

Computation  of  tax. — Income  subject  to  tax  at  the 
rates  in  effect  for  the  year  1917. 

1.  Income  from  partnership  of  A,  B  &  Com- 
pany      $25,000 

The  partnership  books  closed  March  31,  1917. 
By  the  provisions  of  the  law  the  earnings  for 
the  fiscal  year  are  to  be  prorated  between  the 
calendar  years  1916  and  1917  on  the  basis  of 
the  number  of  months  in  each  calendar  year. 
Nine  months  of  the  fiscal  year  are  in  the  calen- 
endar  year  1916.  Therefore,  three-fourths  of 
the  income  of  the  partnership,  or  $75,000,  is 
held  to  be  earned  in  1916  and  is  subject  only  to 
the  taxes  in  effect  for  the  year  1916. 

2.  Stock  dividend  on  stock  of  the  X,  Y,  Z 
Corporation.1 

iSee  pages  88-98. 


INDIVIDUAL   INCOME    TAX  157 

An  examination  of  the  surplus  account  of  the 
X,  Y,  Z  Corporation  on  the  preceding  page 
makes  it  evident  that  no  part  of  the  stock  divi- 
dend was  paid  out  of  surplus  earned  in  1917, 
for  the  examination  shows  that  the  dividend 
was  declared  January  1,  1917,  before  the  earn- 
ings for  1917  could  be  determined.  For  that 
reason  no  part  of  the  dividend  is  subject  to  the 
super-tax  imposed  by  the  act  of  October  3,  1917. 
The  law  itself  provides  that  dividends  will  be 
treated  as  having  been  paid  out  of  the  most  re- 
cently accumulated  surplus.  Therefore,  the 
dividend  in  question  must  be  treated  as  paid 
out  of  the  surplus  accumulated,  as  follows: 

$3,000,000  accumulated  in  1916 30% 

3,000,000  accumulated  in  1915 30% 

4,000,000  accumulated  in  1914 40% 

$10,000,000  total  dividend   100% 

The  law  further  provides  that  the  dividends 
should  be  taxed  at  the  rate  in  effect  for  the 
year  in  which  the  surplus  out  of  whieh  they 
were  paid  was  accumulated.  Of  the  $100,000 
stock  dividend  received,  70  per  cent,  or  $70,000, 
should  be  taxed  at  the  rate  in  effect  for  the 
years  1914  and  1915,  and  $30,000  should  be 
taxed  at  the  rates  in  effect  for  the  year  1916. 

3.  Regular  cash  dividend  on  the  stock  of  the 

X,  Y,  Z  Corporation $10,000 

4.  Interest  on  bonds   5,000 

Total  income    $40,000 

Less  excess  profits  tax  on  partnership ....     10,000 

Net  income  on  which  income  tax  will  be 
calculated    $30,000 


158  INCOME    AND    FEDERAL    TAX   REPORTS 

Calculation  of  Normal  Tax 

Income  subject  to  tax $30,000 

Less  deductions: 

Dividends    $10,000 

Personal  exemption  2,000 

Total  deductions    777777    12,000 

Net  income  subject  to  2  per  cent  tax.  $18,000 

Normal  tax  under  act  of  October  3,  1917 : 

Tax  on  $18,000  at  2  per  cent.       $360 

Less    additional    exemp- 
tion of   2,000 

Net  income  subject  to  2 
per  cent  $16,000 

Normal  tax  under  act  of  September  8,  1916: 

Tax  on  $16,000  at  2  per  cent 320 

Total  normal  tax $680      — 

Less  tax  withheld  at  source,  2  per  cent  of 
$5,000  (interest  on  tax-free  bonds) . . .       100 
Balance  of  normal  tax  due $580 

Super-tax  as  calculated  with  use  of  chart  shown 
on  page  preceding,  on  net  income  of  $30,000. 

1.  Largest  sum  in  Column  A  which  is 

less  than  the  amount  of  the  total  net 
income     $20,000 

2.  Total  surtax  thereon  shown  in  Column 

E    $500 

3.  Eemainder  of  net  income  after   sub- 

tracting Item  1  above $10,000 

4.  Surtax    on    this    remainder    at    rate 

shown  in  Column  C  on  line  below 

that  from  which  Item  1  was  taken. .       800 

Total  surtax  due  (sum  of  Items  2  and  4) . .     $1,300 
Additional  tax  due  on  income  earned  in  1914, 
1915,  1916,  as  explained  below 7,950 

Total  tax  due $9,830 


INDIVIDUAL    INCOME    TAX 


159 


Explanation  of  additional  tax.  —  In  arriving  at  the 
amount  of  income  subject  to  tax  we  omitted  certain  in- 
come because  it  was  earned  in  1916  or  previous  years. 
The  income  omitted  was  as  follows: 

Earned  in  1916. 

Partnership  profits   $75,000 

Dividends    30,000 

Total  earned  in  1916 $105,000 

Earned  in  1911f  and  1915. 
Dividends    70,000 

Total  income  omitted $175,000 

Calculation  of  additional  tax  on  income  earned 
in  1916. 
Normal  tax  of  2  per  cent  on  $75,000  (part- 
nership profits)    $1,500 

(Dividends  are  not  subject  to  normal  tax.) 

Super-tax. — This  must  be  calculated  on  $105,- 
000  of  net  income  in  excess  of  the  amount  of 
net  income  of  $30,000,  that  is,  on  $105,000,  or 
net  income  between  $30,000  and  $135,000  at  the 
rates  in  effect  for  1916. 


$30,000  to  $40,000 $10,000  at  1% 

40,000  to    60,000 20,000  at  2 

60,000  to    80,000 20,000  at  3 

80,000  to  100,000 20,000  at  4 

100,000  to  135,000 35,000  at  5 


$100 
400 
600 
800 

1,750 


$105,000 
Total  super-tax   3,650 

Total  additional  tax  on  income  earned  in 
1916    $5,150 


160  INCOME    AND    FEDERAL    TAX    REPORTS 

Calculation  of  additional  tax  on  income  earned 
in  1914  and  1915. — This  must  be  calculated  on 
$70,000  in  excess  of  the  total  amount  of  net  in- 
come on  which  the  tax  has  been  calculated, 
that  is,  on  $70,000  of  income  between  $135,000 
and  $205,000  at  the  rates  imposed  by  the  act 
of  October  3,  1913.  These  rates  are  shown  by 
the  following  chart: 

$20,000  to      $40,000 1% 

40,000  to        50,000 1 

50,000  to        60,000 2 

60,000  to        75,000 2 

75,000  to        80,000 3 

80,000  to      100,000..... 3 

100,000  to      150,000 4 

150,000  to      200,000 4 

200,000  to      250,000 4 

250,000  to      300,000 5 

300,000  to      500,000 5 

500,000  to   1,000,000 6 

1,000,000  to   1,500,000 6 

1,500,000  to   2,000,000 6 

Over  2,000,000  6 

The  super-tax  will  be  calculated  as  follows : 
$135,000  to  $205,000— $70,000  at  4% $2,800 

Total  additional  tax $7,950 

Assessment  of  tax. — There  is  no  obligation  to  pay  the 
tax  or  any  part  of  it  at  the  time  of  filing  the  return 
with  the  collector.  Assessment  is  made  by  the  Com- 
missioner of  Internal  Eevenue,  and  a  notice  of  the 
amount  of  the  tax  is  later  sent  by  the  collector  of  in- 
ternal revenue  to  the  individual  on  or  before  June  1  of 
the  year  in  which  the  return  is  filed. 

Payment  of  the  tax. — The  tax  should  be  paid  before 
June  15th,  but  no  penalty  will  be  incurred  for  non-pay- 


INDIVIDUAL   INCOME    TAX  161 

ment  until  10  days  after  notice  and  demand  for  the  tax 
by  the  collector. 

Payment  of  the  tax  may  be  made  in  cash,  checks, 
or  the  Treasury  certificates  of  indebtedness. 

Uncertified  checks  may  now  be  accepted  by  collectors 
in  payment  of  Income  and  Excess  Profits  taxes.  If 
such  a  check  is  not  paid  by  the  bank  on  which  it  is 
drawn,  the  person  by  whom  it  has  been  tendered  re- 
mains liable  for  the  payment  of  the  tax  and  to  all  the 
legal  penalties  or  additions  to  the  tax  which  are  pro- 
vided in  case  no  payment  is  made. 

Advance  and  partial  payments. — The  amendment  of  Oc- 
tober 3,  1917,  provides  for  advance  installment  pay- 
ments for  Income  and  Excess  Profits  taxes. 

A  payment  of  at  least  one-fourth  of  the  estimated 
amount  of  the  tax  must  be  paid  within  30  days  after 
the  close  of  the  year  (i.e.,  on  or  before  January  30), 
an  additional  one-fourth  within  two  months  of  the  close 
of  the  year  (i.e.,  on  or  before  February  28) ;  an  addi- 
tional one-fourth  within  four  months  after  the  close 
of  the  taxable  year  (i.e.,  April  30th),  and  the  balance 
on  or  before  the  time  fixed  by  law  (i.e.,  June  15). — 
Income  Tax  Law,  Section  1009. 

Interest  allowed  on  advance  payments. — Credit  will  be 
allowed  on  any  taxes  paid  in  advance  or  installments 
at  a  rate  not  to  exceed  3  per  cent  per  annum  from  the 
date  of  payment  to  the  date  when  the  tax  would  other- 
wise be  due  (i.e.,  June  15).  No  interest  will  be  allowed 
on  payments  made  after  May  15,  nor  on  any  payments 
made  in  excess  of  the  amount  determined  to  be  due. 

It  should  be  noticed  that  by  starting  to  make  install- 
ment payments  the  individual  obligates  himself  to  con- 
tinue them,  and  also  makes  himself  liable  to  all  the  pen- 
alties for  non-payment  of  the  tax  if  he  fails  to  meet 
any  installment  when  due. 

The  following  instructions  relative  to  advance  pay- 
ments in  installments  and  in  whole  of  Income  and  Ex- 


162  INCOME    AND    FEDERAL    TAX    REPORTS 

cess  Profits  taxes  have  been  issued  by  the  Treasury 
Department  under  Section  1009  of  the  Act  of  October 
3,  1917 : 

If  taxpayers  elect  to  make  advance  partial  payments  on  their  income  or 
excess  profits  taxes,  or  both,  as  provided  by  Section  1009  of  the  Act  of 
October  3,  1917,  at  least  one- fourth  of  the  estimated  tax  due  must  be  paid 
within  thirty  days  after  the  close  of  the  taxable  year,  at  least  an  addi- 
tional fourth  within  two  months  after  the  close  of  the  taxable  year,  and 
the  remainder  of  the  tax  due  on  or  before  the  time  now  fixed  by  law  for 
such  payment.  For  the  first  taxable  year,  this  means  in  the  case  of  part- 
nerships and  corporations  who  do  not  fix  their  own  fiscal  years  and  in  the 
case  of  individuals  that  at  least  one-fourth  of  the  estimated  tax  due  must 
be  paid  on  or  before  January  30,  1918,  at  least  an  additional  fourth  on  or 
before  February  28,  1918,  at  least  an  additional  fourth  on  or  before  April 
30th,  1918,  and  the  remainder  of  the  tax  due  on  or  before  June  15,  1918. 
In  the  case  of  a  partnership  or  corporation  whose  fiscal  year  ends  July  31, 
for  example,  at  least  one-fourth  of  the  estimated  tax  due  must  be  paid 
on  or  before  August  30,  at  least  an  additional  fourth  on  or  before  Septem- 
ber 29,  at  least  an  additional  fourth  on  or  before  November  28,  and  the 
remainder  of  the  tax  due  on  or  before  January  12,  165  days  after  the  close 
of  its  fiscal  year.  Taxpayers  are  not  allowed  under  these  regulations  to 
make  advance  payments  in  installments  or  in  whole  before  the  close  of 
their  taxable  year.  Upon  the  first  three  installments,  interest  at  the  rate 
of  3  per  cent  per  annum  (3G5  days)  will  be  allowed  from  the  date  each 
payment  is  made  to  the  date  now  fixed  by  law  for  such  payment.  If  the 
final  payment  is  made  within  4%  months  after  the  close  of  the  taxable 
year,  interest  at  the  rate  of  3  per  cent  per  annum  (365  days)  will  be 
allowed  from  the  date  of  payment  to  the  date  now  fixed  by  law  for  such 
payment. 

In  arriving  at  the  amount  of  the  fourth  installment  required  to  satisfy 
the  assessed  tax,  it  will  be  necessary  to  find  the  difference  between  the 
assessed  tax  and  the  sum  of  the  first  three  installments  and  the  interest 
at  3  per  cent  per  annum  (365  days)  on  same  from  the  dates  of  payment 
to  the  date  now  fixed  by  law  for  such  payment.  This  difference  will  be 
the  amount  of  the  fourth  installment,  if  said  installment  is  paid  after  the 
expiration  of  4%  months  after  the  close  of  the  taxable  year,  since  Sec. 
1009  provides  that  no  credit  for  interest  shall  be  allowed  on  payments  in 
excess  of  taxes  determined  to  be  due,  nor  on  payments  made  after  the 
expiration  of  4%  months  after  the  close  of  the  taxable  year. 

If  the  fourth  installment  is  paid  before  the  expiration  of  4%  months 
after  the  close  of  the  taxable  year,  the  amount  of  such  installment  will  be 
found  by  dividing  the  difference  mentioned  in  the  preceding  paragraph 
by  1.00  plus  the  interest  at  3  per  cent  per  annum  (365  days)  on  $1  for 
the  number  of  days  from  the  date  on  which  said  fourth  installment  is  paid 
to  date  now  fixed  by  law  for  such  payment. 

For  example,  a  taxpayer  on  January  15,  1918,  files  an  income  or  excess 
profits  tax  return  showing  a  tax  liability  of  $4,000  and  with  the  return 


INDIVIDUAL    INCOME    TAX  163 

makes  partial  payment  of  $1,000;  February  25,  1918,  makes  a  second  pay- 
ment of  $1,000;  March  25,  1918,  a  third  payment  of  $1,000;  and  the  bal- 
ance May  1,  1918. 

The  first  payment  draws  interest  at  the  rate  of  3  per  cent  per  annum 
from  January  15  to  June  15,  151  days  (in  January,  16;  February,  28; 
March,  31;  April,  30;  May,  31;  and  June,  15),  or  $12.41,  amount  $1,012.41; 
the  second  payment,  110  days  (February,  3;  March,  31;  April,  30;  May, 
31;  and  June,  15),  or  $9.04,  amount  $1,009.04;  and  the  third  payment,  82 
days  (March,  6;  April,  30;  May,  31;  and  June,  15),  or  $6.74  ($6,739), 
amount  $1,006.74.  The  sum  of  the  three  payments  and  interest  thereon 
is  $3,028.19,  making  the  difference  $971.81.  The  amount  to  be  paid  on 
May  1,  1918,  to  satisfy  this  difference  is  found,  by  dividing  $971.81,  by 
1.00369863,  the  "amount"  of  $1  for  45  days  (May,  30;  and  June,  15), 
at  3  per  cent,  to  be  $968.23  ($968,228). 

If,  in  the  example  given  above,  the  fourth  payment  were  made  May  16, 
1917,  the  taxpayer  would  be  required  to  pay  the  whole  of  the  difference, 
$971.81,  as  no  interest  would  be  allowable  on  same  under  the  law. 

If  the  taxpayer  elects  to  pay  the  whole  of  the  tax  in  advance,  that  is, 
after  the  close  of  the  taxable  year  and  prior  to  the  expiration  of  4% 
months  after  the  close  of  the  taxable  year,  the  amount  to  be  paid  to 
satisfy  the  tax  will  be  determined  by  dividing  the  amount  of  said  tax  by 
1.00  plus  the  interest  on  $1  at  3  per  cent  per  annum  (365  days)  for  the 
number  of  days  from  the  date  of  payment  to  the  date  now  fixed  by  law 
for  such  payment. 

If  the  advance  payment  in  whole  is  made  at  the  time  of  filing  the  return, 
and  if  upon  the  examination  of  such  return  in  this  office,  it  is  found  that 
the  payment  was  in  excess  of  the  amount  required,  together  with  the 
interest  thereon  to  satisfy  the  tax  actually  due,  the  taxpayer  will  be 
entitled  to  the  refund  of  the  amount  of  excess  payment  (but  not  the 
interest  thereon)   by  making  claim  for  same  on  Form  46. 

In  arriving  at  the  amount  of  excess  payment,  the  tax  assessed  should 
be  divided  by  1.00  plus  the  interest  at  3  per  cent  per  annum  (365  days) 
on  $1  for  the  number  of  days  from  the  date  of  payment  to  the  date  now 
fixed  by  law  for  such  payment.  The  difference  between  the  amount  actually 
paid  in  advance  and  the  quotient  will  be  the  amount  of  excess  payment. 

The  interest  at  the  rate  of  3  per  cent  per  annum  (365  days),  allowed 
to  a  taxpayer  on  advance  payments  on  income  and  excess  profits  taxes, 
must  be  considered  income  and  accounted  for  as  income  by  the  taxpayer 
in  his  return  for  the  year  in  which  said  interest  is  allowed. 


INTEREST  TABLE 

Interest  on  $1.00  at  3  per  cent,  per  365  Days,  1  Day  to  165  Days 


Days 

Interest 

Days 

Interest 

Days 

Interest 

1 

$0.000082192 

56 

SO. 004602740 

111 

80.009123288 

2 

.000164384 

57 

.004684932 

112 

.009205479 

3 

.000246575 

58 

.004767123 

113 

.009287671 

4 

.000328767 

59 

.004849315 

114 

.009369863 

5 

.000410959 

60 

.004931507 

115 

.009452055 

6 

.000493151 

61 

.005013699 

116 

.009534247 

7 

.000575342 

62 

.005095890 

117 

.009616438 

8 

.000657534 

63 

.005178082 

118 

.009698630 

9 

.000739726 

64 

.005260274 

119 

.009780822 

10 

.000821918 

65 

.005342466 

120 

.009863014 

11 

.000904110 

66 

.005424658 

121 

.009945205 

12 

.000986301 

67 

.005506849 

122 

.010027397 

13 

.001068493 

68 

.005589041 

123 

.010109589 

14 

.001150685 

69 

.005671233 

124 

.010191781 

15 

.001232877 

70 

.005753425 

125 

.010273973 

16 

.001315068 

71 

.005835616 

126 

.010356164 

17 

.001397260 

72 

.005917808 

127 

.010438356 

18 

.001479452 

73 

.006000000 

128 

.010520548 

19 

.001561644 

74 

.006082192 

129 

.010602740 

20 

.001643836 

75 

.006164384 

130 

.010684932 

21 

.001726027 

76 

.006246575 

131 

.010767123 

22 

.001808219 

77 

.006328767 

132 

.010849315 

23 

.001890411 

78 

.006410959 

133 

.010931507 

24 

.001972603 

79 

.006493151 

134 

.011013699 

25 

.002054795 

80 

.006575342 

135 

.011095890 

26 

.002136986 

81 

.006657534 

136 

.011178082 

27 

.002219178 

82 

.006739726 

137 

.011260274 

28 

.002301370 

83 

.006821918 

138 

.011342466 

29 

.002383562 

84 

.006904110 

139 

.011424658 

30 

.002465753 

85 

.006986301 

140 

.011506849 

31 

.002547945 

86 

.007068493 

141 

.011589041 

32 

.002630137 

87 

.007150685 

142 

.011671233 

33 

.002712329 

88 

.007232877 

143 

.011753425 

34 

.002794521 

89 

.007315068 

144 

.011835616 

35 

.002876712 

90 

.007397260 

145 

.011917808 

36 

.002958904 

91 

.007479452 

146 

.012000000 

37 

.003041096 

92 

.007561644 

147 

.012082192 

38 

.003123288 

93 

.007643836 

148 

.012164384 

39 

.003205479 

94 

.007726027 

149 

.012246575 

40 

.003287671 

95 

.007808219 

150 

.012328767 

41 

.003369863 

96 

.007890411 

151 

.012410959 

42 

.003452055 

97 

.007972603 

152 

.012493151 

43 

.003534247 

98 

.008054795 

153 

.012575342 

44 

.003616438 

99 

.008136986 

154 

.012657534 

45 

.003698630 

100 

.008219178 

155 

.012739726 

46 

.003780822 

101 

.008301370 

156 

.012821918 

47 

.003863014 

102 

.008383562 

157 

.012904110 

48 

.003945205 

103 

.008465753 

158 

.012986301 

49 

.004027397 

104 

.008547945 

159 

.013068493 

50 

.004109589 

105 

.008630137 

160 

.013150685 

51 

.004191781 

106 

.008712329 

161 

.013232877 

52 

.004273973 

107 

.008794521 

162 

.013315068 

53 

.004356164 

108 

.008876712 

163 

.013397260 

54 

.004438356 

109 

.008958904 

164 

.013479452 

55 

.004520548 

110 

.009041096 

165 

.013561644 

CHAPTER  VII 

CORPORATION  INCOME  TAX 

CORPORATIONS   AND   ASSOCIATIONS 
SUBJECT  TO  TAX 

Income  Tax  laws. — The  Income  Tax  law  of  September 
8,  1916,  levies  a  tax  upon  the  net  income  of  every  cor- 
poration, joint-stock  company  or  association  and  insur- 
ance company  organized  in  the  United  States,  no  matter 
how  organized  or  created.  The  War  Income  Tax  law 
of  October  3,  1917,  imposed  an  additional  tax  upon  all 
organizations  subject  to  the  tax  under  the  1916  law. 

Partnerships  pay  tax  as  individuals. — The  partnership 
form  of  organization  is  not  included  in  the  list  of  or- 
ganizations subject  to  the  corporation  income  tax.  No 
income  tax  return  is  required  of  partnerships  as  such, 
the  individual  members  of  the  partnership  being  taxed 
for  their  respective  shares  of  the  net  income. 

Limited  partnerships  are  associations. — Limited  part- 
nerships, however,  are  held  to  be  associations  within 
the  meaning  of  the  Income  Tax  Law  and,  for  income 
tax  purposes,  are  treated  as  corporations. 

Joint-stock  company  or  association. — The  term  "joint- 
stock  companies  or  associations"  includes  associations 
and  real  estate  trusts,  commonly  known  as  Massachu- 
setts Trusts,  whether  organized  under  State  laws,  trust 
agreements,  declarations  of  trust  or  otherwise.  They 
will  be  taxed  as  associations  in  all  cases  where  the  net 
income  is  distributed  or  distributable  on  the  basis  of 
stock  holdings  in,  or  capital  contributed  to,  the  organi- 
zation.1 

i  A  Massachusetts  Trust  is  a  form  of  organization  in  which  title  to 
property  is  vested  in  trustees  for  the  benefit  of  the  members.    Each  mem- 

165 


166  INCOME    AND    FEDERAL    TAX    REPORTS 

Every  corporation  must  file  return. — Every  corporation, 
unless  specifically  enumerated  as  exempt,  must  make  a 
return  of  its  annual  net  income  required  by  law  whether 
or  not  it  has  any  income  liable  to  tax  or  whether  or  not 
it  is  subordinate  to  or  controlled  by  another  corporation. 

Moreover,  the  tax  is  imposed  not  only  on  those  cor- 
porations that  are  organized  and  operated  for  profit, 
but  also  on  any  corporation,  joint-stock  company  or 
association,  and  any  insurance  company,  no  matter  how 
created  or  organized,  or  what  the  purpose  of  its  organi- 
zation may  be,  unless  it  comes  within  the  class  of  organ- 
izations specifically  enumerated  in  the  act  as  exempt. 
And  such  organizations  will  be  required  to  make  returns 
of  annual  net  income  and  must  pay  an  income  tax  upon 
the  net  income  which  arises  and  accrues  to  them  during 
the  year. 

Corporation  subsidiaries.  —  Every  corporation,  joint- 
stock  company  or  association,  and  every  insurance  com- 
pany regardless  of  its  relation  to  another  corporation, 
is  a  separate  and  distinct  entity  and  unless  it  comes 
within  the  class  of  exempt  organizations,  it  must  make 
a  separate  and  distinct  return,  complete  in  every  detail. 
The  net  earnings  of  the  subsidiary  company,  turned  over 
to  the  parent  company,  are  dividends  within  the  mean- 
ing of  the  1913  and  1916  laws,  and  as  such  dividends 
are  not  deductible  from  gross  income,  the  parent  com- 
ber receives  a  certificate  of  beneficial  interest  in  the  property  of  the 
"trust." 

Under  the  decision  of  Eliot  vs.  Freeman,  et  al  (220  U.  S.,  178),  Massa- 
chusetts Trusts  were  not  subject  to  the  tax  imposed  by  the  act  of  August 
5,  1909.  This  exemption  does  not  apply  to  the  present  corporation  income 
tax.  The  1909  tax  was  imposed  on  all  corporations  organized  in  the 
United  States,  including  Alaska  and  the  District  of  Columbia,  and  a* 
Massachusetts  Trusts  are  not  organized  under  the  laws  of  any  State,  they 
were  not  subject  to  the  tax. 

The  1913  Income  Tax  law  and  all  subsequent  laws  have  levied  taxes  on 
all  corporations  or  associations  no  matter  how  organized  or  created. 
Clearly  the  use  of  the  word  "created"  was  intended  to  obviate  the  decision 
in  the  Eliot  case,  and  it  therefore  follows  that  Massachusetts  Trusts  are 
not  exempt. 


CORPORATION    INCOME    TAX  167 

pany  must  pay  the  tax  on  its  net  income  notwithstand- 
ing the  fact  that  the  earnings  of  the  subsidiary  out  of 
which  the  dividends  were  paid  had  been  subject  to  tax 
as  against  the  subsidiary.  The  Income  Tax  law  specifi- 
cally sets  forth  that  there  shall  be  returned,  as  gross 
income,  all  income  received  from  all  sources  during  the 
year,  for  which  the  return  is  filed,  and  it  specifically 
enumerates  the  items  which  may  be  deducted  from  such 
gross  income  There  is  no  provision  in  the  act  of  Sep- 
tember 8,  1916,  whereby  dividends  received  from  other 
corporations  may  be  excluded  from  gross  income  or 
deducted  therefrom.  Every  corporation  is  a  separate 
and  distinct  entity  and,  for  the  purpose  of  the  tax,  must 
report  the  income  which  it  receives  (except  interest  on 
obligations  of  the  United  States,  a  State  or  subdivision 
thereof)  regardless  of  the  source  from  which  such  in- 
come is  received  and  regardless  of  the  fact  that  a  por- 
tion of  such  income  may  constitute  dividends  from  other 
corporations  subject  to  like  tax. 

Section  4  of  the  War  Income  Tax  added  by  the  act 
of  October  3,  1917,  imposing  an  additional  4  per  cent 
income  tax  on  corporations  recognizes  this  double  tax- 
ation and  allows  as  a  credit,  before  the  computation  of 
the  additional  4  per  cent  tax,  the  amount  received  as 
dividends  upon  the  stock  or  from  the  net  earnings  of 
any  other  corporation  which  is  taxable  upon  its  net 
income  as  provided  in  Title  I  of  the  War  Income  Tax 
act. 

Thus,  in  the  case  of  a  parent  corporation  owning  all 
or  practically  all  of  the  stock  of  subsidiary  companies, 
both  corporations  are  considered  separate  and  distinct 
entities,  and  each  must  make  a  true  and  accurate  re- 
turn, accounting  for,  in  detail,  the  separate  gross  in- 
comes and  deductions.  Each  company  will  be  required 
to  pay  the  income  tax  on  the  net  earnings  shown  by 
individual  report  (subject  to  the  above  allowance.)  The 
mere  fact  that  the  subsidiary  is  maintained  simply  for 


168  INCOME    AND    FEDERAL    TAX    REPORTS 

the  purpose  of  protecting  certain  brands,  trade-marks, 
or  trade  names  is  immaterial  and  such  a  company  is 
required  to  make  a  return.  Even  if  such  a  company- 
has  no  income  or  earnings  and  its  operating  expenses 
are  paid  by  the  parent  company,  the  subsidiary  must 
make  a  return  clearly  setting  forth  these  facts. 

On  the  other  hand,  if  the  subsidiary  concerns  are 
mere  partnerships  or  branches  of  the  parent  company, 
and  not  separately  incorporated  organizations,  they  will 
not  be  required  to  make  reports  of  annual  net  income, 
but  all  of  their  earnings  and  expenses  should  be  taken 
up  and  accounted  for  in  the  report  of  the  parent  or- 
ganization. 

Close  corporations  must  file  returns. — Very  often  a  cor- 
poration is  formed  as  a  family  affair,  with  the  idea  of 
keeping  the  ownership  in  the  hands  of  two  or  three  in- 
dividuals. Such  a  corporation  does  not  come  within 
the  classification  of  exempt  corporations  and  is  there- 
fore required  to  make  a  return  of  annual  net  income, 
which  will  show  all  the  income  arising  and  accruing  to 
it  from  all  sources.  The  mere  fact  that  the  stock  of 
the  corporation  is  kept  by  a  few  people  and  not  gener- 
ally bought  and  sold  does  not  affect  the  status  of  the 
corporation. 

Corporations  owned  by  exempt  organizations  must  file  re- 
turns.— If  all  of  the  stock  of  a  non-exempt  corporation 
is  owned  by  a  corporation  which  comes  within  the  ex- 
empt classification,  the  former  corporation  is  not  re- 
lieved from  liability  under  the  tax  law.  The  income 
tax  liability  of  a  corporation  does  not  depend  upon  the 
ownership  of  its  stock. 

Corporations  in  existence  for  only  part  of  the  year  must 
file  returns. — All  corporations,  unless  exempt,  in  ex- 
istence during  all,  or  any  part  of  a  taxable  year,  are 
required  to  make  returns  for  that  year.  Dissolved  cor- 
porations whose  fiscal  year  coincides  with  the  calendar 
year  must  make  returns  covering  the  period  from  Janu- 


CORPORATION    INCOME   TAX  169 

ary  1st  to  the  date  of  dissolution.  Defunct  corporations 
which  had  a  fiscal  year  other  than  the  calendar  year 
should  make  returns  covering  the  period  from  the  be- 
ginning of  the  fiscal  year  to  the  date  of  dissolution. 
New  corporations  should  make  returns  for  the  period 
from  the  date  of  their  organization  to  December  31, 
unless  they  have  designated  some  other  date  as  the 
close  of  their  fiscal  year,  and  have  received  permission 
from  the  collector  to  file  return  as  of  a  fiscal  year,  in 
which  case  a  return  should  be  made  covering  the  period 
from  the  date  of  organization  to  the  close  of  the  fiscal 
year. 

Corporations  dissolving  or  liquidating  during  the 
year  may,  at  the  time  of  dissolution  or  liquidation, 
make  and  file  a  final  return  covering  the  income  re- 
ceived or  accrued  to  them  during  the  fractional  part  of 
the  year  in  which  they  were  engaged  in  business.  If 
the  return  shows  a  net  income  for  that  portion  of  the 
year  during  which  the  corporation  was  in  business,  the 
proper  officers  of  the  corporation  should  retain  sufficient 
funds  out  of  which  the  income  tax  assessment  can  be 
paid.  If  funds  for  this  purpose  are  not  retained  the 
tax  office  will  look  to  the  officers  of  the  corporation 
for  the  payment  of  the  tax  shown  to  be  due.  Should 
they  fail  to  pay  the  tax  the  government  may  look  to 
the   stockholders   for   its   payment. 

Corporations  that  have  dissolved  prior  to  October  3, 
1917,  are  held  to  be  liable  for  the  normal  income  tax 
of  2  per  cent  under  the  act  of  September  8,  1916,  the 
War  Income  tax  of  4  per  cent  under  the  act  of  October 
3,  1917,  and  for  the  War  Profits  tax,  also  imposed  under 
the  act  of  October  3,  1917. 

Corporations  organized  but  not  transacting  business  must 
file  returns. — A  corporation  which  has  been  fully  or- 
ganized, but  which  has  transacted  no  business  during 
the  year  of  its  organization  or  any  subsequent  year, 
must  nevertheless,  make  and  file  a  return. 


170  INCOME    AND    FEDERAL    TAX    REPORTS 

Corporations  not  entirely  organized  need  not  file  returns. 
— Corporations  which  have  applied  for  and  never  re- 
ceived charters,  or  corporations  which  have  received 
charters  and  never  perfected  their  organizations,  trans- 
acted no  business  and  had  no  income  whatever  from 
any  source  may,  upon  presentation  of  these  facts  to  the 
collector,  be  relieved  from  the  necessity  of  making 
returns  of  annual  net  income  so  long  as  they  remain 
in  this  unorganized  condition.  Of  course,  if  the  cor- 
poration is  completely  organized,  even  though  it  had 
no  income  during  the  year,  it  must  file  a  return. 

Corporations  engaged  in  agricultural  pursuits  for  profit 
must  file  return. — Corporations  engaged  in  agricultural 
or  horticultural  pursuits  for  profit  are  liable  under  the 
law  to  make  returns  and  to  pay  the  income  tax.  Thus, 
corporations  owning  sugar  or  other  plantations  and 
selling  the  product  are  considered  to  be  operating  for 
profit  and  are  not  entitled  to  exemption  as  agricultural 
organizations. 

Corporations  leasing  their  property. — A  railroad  or  other 
corporation  which  has  leased  its  properties  in  consider- 
ation of  a  rental  equivalent  to  a  certain  rate  of  dividend 
on  its  outstanding  capital  stock  or  the  interest  on  its 
bonded  indebtedness  or  both,  such  rental  being  paid  by 
the  lessee  directly  to  the  stock  and  bondholders,  should 
nevertheless  make  a  return  of  annual  net  income  show- 
ing the  rental  so  paid  as  having  been  received  by  the 
corporation. 

In  paying,  as  rent,  dividends  or  interest  directly  to 
the  shareholders  or  bondholders  of  the  lessor  company, 
the  lessee  company  is  held  to  be  acting  merely  as  the 
agent  of  the  lessor  company.  The  lessor  company 
must,  of  course,  render  an  income  tax  return  which 
will  show  as  gross  income  the  amount  of  rentals  paid 
by  the  lessee  company  to  the  stockholders  and  bond- 
holders of  the  lessor  company.  The  interest  can  then 
properly  be  deducted  as  an  expense. 


CORPORATION    INCOME    TAX  171 

Corporations  operating  leased  properties. — Where  a  cor- 
poration leases  property  which  it  operates,  the  rental 
payment  is  an  operating  expense  and  as  snch  may  be 
deducted.  Even  if  the  rental  payment  is  measured  by 
a  fixed  percentage  of  the  stock  of  the  lessor  company 
and  is  paid  as  dividends  to  the  stockholders  of  the  les- 
sor company,  the  rental  payment  is  an  expense  deduc- 
tible from  the  gross  income  of  the  lessee  company. 

Private  banks  with  corporate  form  of  organization. — Pri- 
vate banks  which  have  the  form  of  corporate  organiza- 
tions, elect  officers  and  a  board  of  managers,  have  a 
distinctive  name,  a  fixed  situs,  and  distribute  their  net 
earnings  upon  the  basis  of  the  amount  of  capital  in- 
vested by  the  members  or  owners,  are  held  to  be  associa- 
tions, and  in  their  organized  capacity  must  file  a  tax 
report  and  pay  the  tax  on  the  same  basis  as  do  cor- 
porations. On  the  other  hand,  private  banks  which  do 
not  have  this  formal  organization,  but  which  transact 
business,  not  in  the  name  of  the  bank,  but  in  the  name 
of  the  individuals  who  compose  the  firm,  are  copartner- 
ships, and  as  such  are  not  required  to  make  a  return. 
Each  of  the  individuals  comprising  such  a  partnership 
will  be  required  to  render  an  individual  income  report 
and  pay  the  individual  income  tax  thereon.1  Of  course 
if  the  private  bank  is  a  limited  partnership  it  is  subject 
to  the  corporation  income  tax. 

Foreign  corporations  may  be  subject  to  tax. — Corpora- 
tions, joint-stock  companies  or  associations  and  insur- 
ance companies,  organized,  authorized  or  existing  under 
the  laws  of  any  foreign  country  must  report  and  pay 
a  tax  upon  the  amount  of  net  income  accruing  from 
business  transacted  and  capital  invested  within  the 
United  States.  In  case  such  a  corporation  has  several 
branches  in  the  United  States,  it  should  designate  one  of 
them  as  the  principal  branch  and  have  it  render  a  report 
covering  the  income  of  all  branches  in  this  country. 

i  See  page  71. 


172  INCOME    AND    FEDERAL    TAX   REPORTS 

Even  if  a  foreign  corporation  does  not,  strictly 
speaking,  have  a  branch  office  in  the  United  States,  but 
transacts  business  or  has  capital  invested  in  the  United 
State  through  and  by  an  agent,  it  will  be  subject  to  the 
tax  just  as  though  it  were  transacting  business  or  in- 
vesting the  capital  direct  from  the  home  office  or 
through  regular  branches.  Any  net  income  arising  or 
accruing  from  the  business  of  such  an  agent  will  be 
subject  to  the  corporation  income  tax;  and  it  is  the 
duty  of  the  foreign  corporation  in  such  a  case  to  ren- 
der a  report  of  the  business  transacted  through  the 
agent.  And  so,  too,  when  a  foreign  corporation  sends 
a  representative  to  the  United  States  to  solicit  business, 
with  the  understanding  that  the  goods  are  to  be  shipped 
direct  to  the  purchaser,  it  is  held  that  such  a  corpora- 
tion is  doing  business  in  this  country  and  must  pay  a 
tax  on  the  net  income  arising  or  accruing  to  the  cor- 
poration from  such  transactions.  The  mere  fact  that 
the  solicitor  has  only  a  mailing  address  in  this  country 
makes  no  difference,  for  he  is  still  held  to  be  an  agent 
of  the  foreign  corporation. 

CORPORATIONS  EXEMPT  FROM  THE  INCOME  TAX 

Corporations  which  are  exempt  from  income  tax. — Cer- 
tain corporations  and  organizations  are  entirely  or  con- 
ditionally free  from  income  taxes,  and  are  not  required 
to  render  income  tax  reports.  The  law  itself,  Section 
11,  lists  such  corporations  and  organizations.  The  ex- 
emption from  the  payment  of  taxes  applies  not  only  to 
such  domestic  corporations  as  are  enumerated  in  sec- 
tion 11  of  the  law,  but  also  to  foreign  corporations  which 
come  within  the  definition  of  exempt  organizations.  In 
any  event,  a  corporation  which  claims  to  come  within 
the  exempt  classifications  of  section  11  of  the  law  should 
file,  with  the  Collector  of  Internal  Kevenue,  an  affidavit 
showing  the  basis  of  its  claim  for  exemption.  This 
affidavit  must  include: 


CORPORATION    INCOME    TAX  173 

1.  The  purpose  and  nature  of  the  organization. 

2.  The  source  of  its  income. 

3.  The  disposition  of  its  income. 

4.  Whether  or  not  any  of  its  income  will  ever  inure 
to  the  benefit  of  any  private  stockholder  or  individual. 

5.  If  the  organization  is  a  foreign  organization  and 
doubt  exists  as  to  whether  or  not  it  is  exempt,  there 
should  be  attached  a  copy  of  its  charter  and  by-laws. 

If  the  affidavit  thus  submitted  is  not  satisfactory  the 
organization  may  be  required  to  file  a  report.  If  it  is 
satisfactory  and  the  organization  comes  within  the  ex- 
empt class,  the  organization  will  be  definitely  advised 
as  to  its  status. 

Labor,  agricultural,  or  horticultural  organizations. — La- 
bor unions  and  similar  labor  organizations  are  exempt. 
Agricultural  and  horticultural  associations  which  are 
also  exempt,  include  such  associations  as  county  fairs 
or  like  organizations  not  themselves  engaged  in  agricul- 
tural or  horticultural  pursuits,  but  which  by  means  of 
awards,  premiums,  etc.,  attempt  to  encourage  better 
production.  To  be  exempt,  however,  no  part  of  their 
income  may  inure  to  the  benefit  of  any  private  stock- 
holder or  individual. 

Fruit  growers  associations,  whose  purpose  it  is  to 
promote  the  mutual  benefit  of  their  members  in  market- 
ing their  products  and  which  are  not  organized  for 
profit  and  have  no  capital  stock  represented  by  shares, 
and  whose  income  is  derived  wholly  from  membership 
fees,  dues,  and  assessments  to  meet  necessary  expenses, 
are  also  horticultural  societies  within  the  meaning  of 
the  law.  They  are  not  subject  to  tax  nor  are  they 
required  to  make  a  report  of  their  income.  They 
should,  however,  file  the  affidavit  mentioned  in  the 
preceding  paragraph. 

Mutual  savings  banks  not  having  a  capital  stock  repre- 
sented by  shares. — Any  mutual  savings  bank  organized 


174  .         INCOME   AND    FEDERAL    TAX   REPORTS 

merely  for  the  purpose  of  affording  a  means  of  mutual 
savings  and  investment  is  exempt  from  the  income  tax. 

Fraternal  beneficiary  societies. — Any  beneficiary  society, 
order  or  association  operating  under  the  lodge  system 
and  providing  for  the  payment  of  life,  sick,  accident  or 
other  benefits  to  the  members  of  such  societies,  orders 
or  associations  or  their  dependents  are  exempt.  Of 
course,  in  this  exemption  are  included  all  societies  or 
associations  operating  under  a  charter  with  properly 
appointed  or  elected  officers,  with  an  adopted  ritual  or 
ceremonial,  holding  meetings  at  stated  intervals,  and 
supported  by  fees,  dues  or  assessments. 

Building  and  loan  associations  and  co-operative  banks. — 
Domestic  building  and  loan  associations,  and  co-opera- 
tive banks  without  capital  stock,  organized  and  operated 
for  mutual  purposes  and  without  profit,  are  exempt 
from  the  tax. 

A  domestic  building  and  loan  association  is  one  or- 
ganized under  the  laws  of  the  United  States  or  of  a 
State  or  Territory  of  the  United  States,  *or  under  the 
laws  applicable  to  Alaska  or  the  District  of  Columbia. 
To  be  exempt  it  is  absolutely  essential  that  the  build- 
ing and  loan  association  be  "mutual"  in  its  operation 
and  in  its  distribution  of  profits  and  benefits.  There- 
fore, in  order  to  come  within  the  exempt  class  such 
associations  must  not  only  be  "domestic,"  as  defined, 
but  they  must  be  operated  exclusively  for  the  mutual 
benefit  of  the  members.  All  the  profits  and  benefits 
provided  for  in  the  articles  of  association  and  by-laws 
must  be  ratably  distributed  among  all  the  members  re- 
gardless of  the  kind  of  stock  held,  according  to  the 
amount  of  money  they  have  on  deposit.  If  an  asso- 
ciation issues  different  classes  of  stock  upon  which 
different  rates  of  interest  or  dividends  are  guaranteed 
or  paid,  it  does  not  come  within  the  exempt  class.  Or 
if  one  class  of  stock  is  preferred  in  dividends  or  other- 
wise over  another  class,  the  association  would  not  be 


CORPORATION    INCOME    TAX  175 

exempt.  But  the  mere  fact  that  an  otherwise  "mutual" 
building  and  loan  association  issues  two  classes  of 
stock,  one  of  which  is  paid  for  in  full  at  the  time  of 
issue,  and  the  other  of  which  is  paid  for  in  installments, 
does  not  affect  the  "mutuality"  of  the  association. 

Cemetery  companies. — Cemetery  companies,  organized 
and  operated  exclusively  for  the  mutual  benefit  of  their 
members  are  exempt.  But  the  provisions  of  the  law 
clearly  indicate  that  companies  which  operate  ceme- 
teries for  profit  are  liable  to  the  tax.  The  taxability 
of  cemetery  associations,  therefore,  depends  upon  the 
character  and  purpose  of  the  organization  and  what 
disposition  is  made  of  the  income.  To  obtain  exemp- 
tion, a  mutual  cemetery  company  should  file  the  neces- 
sary affidavit  showing  the  basis  of  its  claim  for  ex- 
emption. 

Religious,  charitable,  scientific  and  educational  associa- 
tions.— Corporations  or  associations  organized  and  oper- 
ated exclusively  for  religious,  charitable,  scientific,  or 
educational  purposes,  no  part  of  the  net  income  of 
which  inures  to  the  benefit  of  any  private  stockholder 
or  individual  are  exempt. 

Under  this  heading  are  included  churches,  leagues, 
chambers  of  commerce  or  boards  of  trade,  not  organ- 
ized for  profit  and  no  part  of  the  net  income  of  which 
inures  to  the  benefit  of  any  private  stockholder  or 
individual.  Of  course  private  schools  which  are  run 
for  profit  and  for  the  private  gain  of  stockholders  or 
individuals  are  not  exempt. 

Civic  leagues. — Civic  leagues  or  organizations  not  or- 
ganized for  profit,  but  operated  exclusively  for  the  pro- 
motion of  social  welfare,  are  exempt. 

Pleasure  and  social  clubs. — Social  clubs  which  are  or- 
ganized and  conducted  exclusively  for  pleasure,  recrea- 
tion and  other  non-profitable  purposes  and  which  have 
no  net  income  inuring  to  the  benefit  of  any  private  stock- 
holder,  individual,    or   member,   are   exempt.    But   all 


176  INCOME   AND    FEDERAL    TAX   REPORTS 

clubs  are  not  exempt  from  the  provisions  of  the  Income 
Tax  law,  and  this  is  time  even  though  they  are  not 
operated  for  profit.  A  club  which  desires  to  be  exempt 
and  to  be  registered  as  an  exempt  organization  should 
file  with  the  Collector  of  Internal  Revenue  either  a 
copy  of  its  charter,  or  an  affidavit  of  its  principal 
officer,  setting  forth  the  facts  required  in  such  affi- 
davits.1 This  is  required  even  in  the  case  of  clubs 
operated  for  purely  social  purposes.  If  such  an  affi- 
davit is  not  filed  it  may  be  necessary  for  the  club  to 
file  an  income  tax  return. 

Mutual  insurance,  irrigation,  telephone  and  other  local 
mutual  companies. — Farmers'  or  other  mutual  hail,  cy- 
clone, or  fire  insurance  companies,  mutual  ditch  or  irri- 
gation companies,  mutual  or  co-operative  telephone 
companies,  or  like  organizations  of  a  purely  local  char- 
acter, the  income  of  which  consists  solely  of  assess- 
ments, dues  and  fees  collected  from  members  for  the 
sole  purpose  of  meeting  its  expenses,  are  exempt. 

Some  trouble  may  be  experienced  by  readers  in  de- 
termining just  which  mutual  companies  are  exempt, 
since  it  is  quite  evident  from  other  parts  of  the  law 
(for  example,  Sec.  12a,  second)  that  this  clause  does 
not  exempt  all  mutual  insurance  companies.  A  strict 
application  of  the  law  is  necessary,  the  test  being  in 
each  case,  does  the  company  fit  the  following  four  re- 
quirements : 

(1)  Is  it  mutual  or  co-operative? 

(2)  Is  it  a  purely  local  association? 

(3)  Does  it  derive  its  income  wholly  from  assess- 
ments, dues  and  fees? 

(4)  Is  the  income  thus  derived  used  for  the  sole  pur- 
pose of  meeting  its  expenses? 

If,  for  example,  such  a  corporation  should  derive  in- 
come from  an  investment  owned  by  the  company,  it 
would  cease  to  be  exempt. 

i  See  following  page. 


CORPORATION    INCOME   TAX  177 

Farmers'  and  fruit  growers'  associations.  —  Farmers', 
fruit  growers'  or  like  associations,  organized  and  oper- 
ated as  sales  agents  for  the  purpose  of  marketing  the 
products  of  their  members  and  turning  back  to  them 
the  proceeds  of  sales,  less  the  necessary  selling  expenses, 
on  the  basis  of  the  quantity  of  produce  furnished  by 
them,  are  exempt.  So  also  are  farmers'  co-operative 
dairy  associations  which  are  organized  and  conducted 
solely  to  sell  the  milk  of  their  members  for  their  mutual 
benefit. 

Certain  realty  corporations  exempt. — Corporations  or 
associations  organized  for  the  exclusive  purpose  of 
holding  title  to  property,  collecting  income  therefrom 
and  turning  over  the  entire  amount  thereof,  less  ex- 
penses, to  an  organization  which  itself  is  exempt  from 
the  tax,  are  exempt. 

Federal  land  banks  and  national  farm  loan  associations 
are  exempt. — Federal  land  banks  and  national  farm  loan 
associations  organized  and  operated  under  the  provis- 
ions of  the  Federal  Farm  Loan  Act  (section  26  of  the 
act  approved  July  17,  1916,  entitled  "An  Act  to  provide 
capital  for  agricultural  development,  to  create  standard 
forms  of  investment  based  upon  farm  mortgages,  to 
equalize  rate  of  interest  upon  farm  loans,  to  furnish  a 
market  for  United  States  bonds,  to  create  Government 
depositaries  and  financial  agents  for  the  United  States 
and  for  other  purposes,"  are  entirely  exempt  from  in- 
come taxes.  Joint-stock  land  banks  are  also  exempt 
as  to  income  derived  from  bonds  or  debentures  of 
other  joint-stock  banks  or  of  any  Federal  land  bank 
belonging  to  such  joint-stock  land  banks. 

Proof  of  exemption  is  required. — The  classes  of  or- 
ganizations enumerated  hereinbefore  comprise  all  of 
the  forms  of  organizations  that  are  exempt  from  the 
income  tax.  It  must  be  borne  in  mind,  however,  that 
the  tax  is  imposed  not  only  on  corporations  which  are 
operated  for  profit,  but  on  all  corporations,  associations, 


178  INCOME    AND    FEDERAL    TAX    REPORTS 

joint-stock  companies,  and  insurance  companies,  no  mat- 
ter what  the  purpose  of  their  organization,  unless  they 
are  included  in  one  of  the  foregoing  groups. 

All  corporations  and  all  beneficiary  societies  which 
claim  exemption  must,  at  the  request  of  the  Collector 
or  Commissioner,  establish  their  right  to  the  exemption 
by  showing  not  only  the  character  and  purpose  of  the 
organization  and  the  manner  of  distributing  the  net 
income,  but  also  that  none  of  the  net  income  inures  to 
the  benefit  of  any  private  stockholder  or  individual. 

In  the  absence  of  such  a  showing  such  an  organization 
may,  at  any  time,  be  required  to  make  returns  of  an- 
nual net  income  or  show  its  books  of  account  to  a 
revenue  officer  for  examination,  in  order  that  the 
status  of  the  company  may  be  determined. 

If  a  corporation  or  beneficiary  society  once  satisfies 
the  Collector  or  Commissioner  that  it  is  exempt,  it  will 
not  be  required  to  make  any  further  showing  or  file  any 
additional  affidavits  unless  the  Collector  or  the  Com- 
missioner has  reason  to  believe  that  the  status  of  the 
organization  has  changed  or  that  it  has  a  net  income 
inuring  to  the  benefit  of  a  private  stockholder  or  mem- 
ber. 

Income  accruing  to  a  State  from  public  utility  corpora- 
tions is  exempt. — The  income  of  any  State  or  political 
subdivision  is  exempt  from  the  tax;  Congress  has  no 
authority  to  levy  any  tax  upon  the  States  themselves. 
It  follows,  therefore,  that  if  a  city  operates  a  public 
utility  the  income  accruing  to  the  city  from  such  util- 
ity is  exempt. 

It  is  becoming  increasingly  common  for  cities  to 
build  or  operate  public  utilities  in  connection  with  a 
private  corporation  on  what  amounts  to  a  partnership 
basis.  To  cover  such  situations  the  Income  Tax  law, 
section  11,  subdivision  (b)  provides  that  in  those  cases 
where  a  State,  territory  or  any  subdivision  has,  before 
September  8,  1916,  made  a  contract  with  an  individual, 


CORPORATION    INCOME    TAX  179 

partnership,  corporation,  or  other  business  associa- 
tion to  operate  a  public  utility,  and  such  contract  gives 
the  State,  territory  or  other  subdivision  a  share  in 
the  profits,  such  share  of  the  income  from  the  opera- 
tion as  accrues  to  the  city  should  be  deducted  by  the 
individual  or  corporation  operating  the  utility  in  com- 
puting the  net  income  subject  to  the  income  tax.  The 
State  or  its  subdivision  therefore  receives  its  share  of 
the  profits  unburdened  with  the  tax. 

To  illustrate:  A  city  has  an  agreement  with  a  cor- 
poration to  operate  a  street  railway,  the  city  to  re- 
ceive one-third  of  the  profits.  The  profits  for  the  year 
1917  amount  to  $300,000.  The  corporation  in  making 
up  its  income  tax  return  would  deduct  the  city's  share 
of  the  profits,  or  $100,000,  and  show  a  net  income  of 
$200,000,  on  which  it  would  pay  the  tax.  The  city 
receives  its  $100,000,  and  pays  no  tax  thereon. 

It  would  seem  that  only  such  income  is  exempt  as 
is  paid  to  a  State  or  subdivision  thereof  under  a  con- 
tract entered  into  prior  to  the  passage  of  the  act 
(Sept.  8,  1916).  That  at  least  is  what  the  law  plainly 
says.  Probably,  however,  the  same  rule  would  apply 
to  cases  where  contracts  are  entered  into  subsequent 
to  the  passage  of  the  act,  for  otherwise  the  income  tax 
would  be  a  burden  on  State  revenues  and  to  such  an 
extent  invalid. 

"Income  accruing  to  the  Government  of  the  Philip- 
pine Islands  or  Porto  Eico,  or  any  political  subdi- 
vision" thereof  is  also  exempt  under  this  provision  of 
the  law. 


CHAPTER  VIII 

CORPORATION  INCOME  TAX 

GROSS  INCOME 

Classification  of  gross  income. — The  gross  income  of 
a  corporation  may  be  classified  under  the  following 
headings : 

Gross  income: 

(a)  From  operations. 

(b)  From  rentals. 

(c)  From  interest. 

(d)  From  dividends  received. 

(e)  From  other  sources. 

Income  to  be  computed  on  an  established  basis. — The 
law  allows  a  corporation,  joint-stock  company  or  asso- 
ciation, or  insurance  company  to  compute  its  income 
upon  a  basis  of  actual  receipts  and  disbursements,  and 
report  simply  the  cash  or  other  income  actually  re- 
ceived. But  in  the  usual  case,  where  a  corporation 
keeps  its  books  in  accordance  with  any  standard  sys- 
tem of  accounting  on  the  so-called  accrual  basis,  the 
corporation  may  report  income  earned  although  not 
yet  received,  and  expenses  incurred  although  not  yet 
paid.  Or  if  a  corporation  keeps  its  books  in  conform- 
ity with  the  requirements  of  any  Federal,  State  or 
municipal  authority,  it  may  make  its  return  on  the 
basis  on  which  its  books  are  kept. 

While  no  particular  system  of  bookkeeping  or  ac- 
counting is  required  by  the  law,  the  books  of  the  cor- 

1S0 


CORPORATION    INCOME    TAX  181 

poration  should  be  so  kept  that  every  item  set  forth 
in  the  income  tax  report  may  be  verified  by  an  exami- 
nation of  the  books.  If  they  are  so  kept  they  will  be 
looked  upon  by  the  Government  as  being  the  best  guide 
in  determining  the  net  income  of  the  corporation. 

And  this  net  income  shown  by  the  books,  or  in  the 
annual  report  to  stockholders  of  a  corporation,  should 
be  the  same  as  shown  in  the  tax  return,  except  in 
those  cases  where  the  income  tax  law  excludes  certain 
income  and  limits  certain  deductions  from  gross  income. 

INCOME   FROM   OPERATIONS 

Gross  income  from  operations. — This  includes  all  gross 
income  resulting  from  the  operations  of  the  corpora- 
tion. A  supplementary  statement  is  required  of  all 
manufacturing  and  mercantile  corporations  which  de- 
termine their  annual  gain  or  loss  by  inventory,  showing 
the  method  of  arriving  at  their  gross  income  from 
operations. 

Inventory  method  of  determining  gain  or  loss. — Most 
manufacturing  and  mercantile  corporations  determine 
their  profit  by  means  of  an  inventory.  The  business 
man  engaged  in  a  mercantile  business  generally  deter- 
mines his  gross  income  as  follows: 

Sales  during  the  year  $50,000 

Cost  of  sales: 

Inventory  at  the  beginning  of  the  year. .     $15,000 
Purchases  during  the  year 25,000 

$40,000 
Less  inventory  at  the  end  of  the  year. .       10,000 

Cost  of  goods  sold  30,000 

Gross  income  from  operations  $20,000 

Sales  during  the  year. — By  the  amount  of  sales  dur- 
ing the  year  is  meant  net  sales,  that  is,  the  total  sales 
less   sales   returns.     Trade   discounts   on  sales   should 


182  INCOME    AND    FEDERAL    TAX    REPORTS 

also  be  deducted  before  stating  the  net  sales,  for  the 
trade  discount  is  simply  a  reduction  of  the  selling  price. 

Allowances  on  sales  for  damages  to  or  losses  of 
goods  sold  should  also  be  deducted  before  stating  the 
net  sales.  Cash  discounts  taken  by  customers  for  pay- 
ment before  due  date  of  bills  should  be  included  under 
general  expenses  and  not  deducted  from  gross   sales. 

Inventory  at  the  end  of  the  year. — The  value  that  is 
placed  upon  the  merchandise  on  hand  at  the  end  of 
the  year  is  a  deciding  element  in  determining  gross 
profit.  The  best  accounting  authorities  hold  that  the 
inventory  should  be  valued  at  cost  or  at  market  value, 
whichever  is  lower.  To  illustrate:  If  an  article  is 
purchased  for  75  cents  and  the  market  value  at  the 
time  of  inventory  is  70  cents,  the  inventory  value 
should  be  70  cents,  but  if  at  the  time  of  inventory  the 
market  value  were  85  cents,  the  cost  price,  or  75  cents, 
would  be  used. 

The  rulings  of  the  Treasury  Department  in  the  past 
have  not  been  in  accord  with  that  principle.  The 
Department  held  until  recently  that  the  inventory 
should  be  figured  at  cost  price,  regardless  of  what  the 
market  price  might  happen  to  be.  The  reason  given 
by  the  Department  was  that  the  profits  or  losses  re- 
sulting from  considering  the  increases  or  decreases  in 
inventory  values  were  not  actual  profits  or  losses,  but 
merely  book  appreciation  or  depreciation  of  values, 
which  might  entirely  disappear  upon  the  sale  of  the 
products  so  inventoried,  and  that  actual  profit  or  loss 
could  not  be  determined  until  the  merchandise  was 
actually  sold  or  disposed  of;  also  that  the  profit  or 
loss  would  at  any  rate  be  reflected  in  the  report  of  the 
subsequent  period  or  periods  and  a  tax  imposed  or  a 
deduction  allowed  in  the  period. 

The  valuing  of  inventory  at  cost  regardless  of  the 
market  price  works  a  hardship  in  a  declining  market, 
because  the  amount  of  tax  cannot  be  properly  adjusted 


CORPORATION    INCOME    TAX  lg3 

from  year  to  year.     To  illustrate:  For  the  year  1915 
the  income  of  corporation  A  was  as  follows: 

Sales    $100,000 

Inventory  at  the  end  of  the  vear,  cost  $40,000 

(market  value,  $25,000") 40,000         $140,000 

Purchases  during  the  year $75,000 

Inventory  at  the  beginning  of  the  year 35,000  110,000 

Gross   income  $30,000 

Expenses    10,000 

Net  income $20,000 

For  the  year  1916  the  income  was : 

Sales   $80,000 

Inventory  at  the  end  of  the  year,  cost  $40,000 

(market  value,  $40,000)    40,000         $120,000 

Purchases  during  the  year $75,000 

Inventory  at  the  beginning  of  the  year 40,000  115,000 

Gross  income  $5,000 

Expenses    10,000 

Net  loss    ' $5,000 

The  corporation  by  complying  with  the  Department's 
rulings  then  showed  an  income  for  the  year  1915  of 
$20,000  on  which  it  had  to  pay  an  income  tax.  For 
1916  there  was  a  loss  of  $5,000  by  the  corporation,  but 
it  did  not  receive  a  refund  on  the  tax  paid  for  the 
previous  year.  The  result  was  that  the  corporation 
had  a  net  income  for  the  two  years  of  $15,000,  but  it 
was  compelled  to  pay  the  tax  on  an  income  of  $20,000, 
which  was,  obviously,  unfair. 

If  the  inventory  at  the  end  of  1915  had  been  figured 
at  the  market  price  of  $25,000,  the  profit  for  1915 
would  have  been  reduced  to  $5,000  and,  correspond- 
ingly, the  loss  for  1916  would  have  been  turned  into  a 
profit  of  $10,000.  The  combined  net  income  for  the 
two  years  would  of  course  be  the  same  as  by  the  other 
method,  but  the  corporation  would  pay  the  tax  only  on 
the  amount  of  net  income  it  had  earned,  or  $15,000. 

The  protests  against  the  old  ruling  eventually  be- 
came so  strong  that  the  Treasury  Department  changed 
its  attitude.     For  the  year  1917  individuals,  partner- 


184  INCOME   AND    FEDERAL    TAX   REPORTS 

ships,  and  corporations  in  computing  their  net  income 
may  calculate  the  inventory  of  merchandise  or  stock 
in  trade  on  hand  either  (1)  at  cost  or  (2)  at  cost  or 
at  market  value,  whichever  is  lower.  This  ruling  brings 
the  Department  in  accord  with  the  majority  of  busi- 
ness men.  Whichever  basis  is  chosen  must,  however, 
be  used  consistently  in  making  subsequent  returns. 

While  the  Department  states  that,  as  between  the 
cost  and  the  market  value,  the  lower  figure  may  be 
used  on  the  income  tax  return,  it  does  not  require  that 
the  same  method  be  used  on  the  books  of  the  corpora- 
tion. The  use  of  the  lower  figure  on  the  return  does 
not  prevent  the  use  of  the  higher  figure  on  the  books 
of  the  individual,  partnership,  or  corporation.  But  it 
must  be  remembered  that  where  returns  are  investi- 
gated the  burden  of  showing  that  the  inventory  figure 
appearing  on  the  books  should  not  be  used  in  com- 
puting the  income,  for  the  purpose  of  the  income  tax 
is  upon  the  taxpayer.  In  such  cases  the  taxpayer 
should  calculate  the  inventory  on  both  bases  (cost  price 
and  market  value)  in  order  to  protect  himself  should 
his  books  be  examined  by  the  Treasury  Department. 

Only  "stock  in  trade"  may  be  inventoried  at  market. — 
Only  such  articles  or  items  as  constitute  stock  in  trade 
may  be  inventoried  at  market  value.  A  dealer  in  se- 
curities may  inventory  unsold  securities  at  market 
value  (when  the  market  value  is  less  than  the  cost 
price)  only  if  he  regularly  inventories  them  at  the 
same  figure  upon  his  books  of  accounts.  But  a  mer- 
cantile corporation  must  inventory  any  securities  it 
owns  at  cost,  because  securities  are  not  part  of  its 
stock  in  trade. 

"Dealer  in  securities"  denned. — A  "dealer  in  securities," 
permitted  to  inventory  his  securities  at  cost,  must  be  a 
merchant  of  securities,  with  an  established  place  of 
business,  whose  principal  business  is  the  purchase  of 
securities  and  their  resale  to  customers.    Such  a  dealer 


CORPORATION    INCOME    TAX  185 

may  be  either  an  individual,  a  partnership,  a  corpora- 
tion, or  other  form  of  business  association.  A  person 
who  buys  or  sells  securities  only  for  his  own  account, 
for  speculation  or  investment,  would  not  be  classed  as 
a  "dealer  in  securities,"  and  is  not  entitled  to  the  option 
of  valuing  his  securities  either  at  cost  or  at  market 
price,  but  is  required  to  inventory  them  at  cost.  More- 
over, members  of  firms  and  officers  of  corporations 
which  are  "dealers  in  securities"  are  not  themselves 
classed  as  such  dealers,  when  acting  in  their  individual 
capacities.  Hence  as  individuals  they  must  inventory 
any  securities  they  own  at  cost. 

Methods  of  taking  inventory. — The  inventory  itself  may 
be  made  in  different  ways.  Of  course  the  most  satis- 
factory method  is  the  taking  of  an  actual  physical  in- 
ventory. This  is  the  method  the  government  prefers, 
and  it  is  obviously  the  most  accurate  method  for  any 
business  man  to  follow.  However,  in  place  of  a  phys- 
ical inventory,  an  "equivalent"  method  that  is  "equally 
accurate"  may  be  used.  While  perhaps  there  is  no 
method  quite  so  accurate  as  the  physical  stock  taking 
method,  the  government  considers  "an  inventory  of 
materials,  supplies  and  merchandise  on  hand  taken 
from  the  books   of  the  corporation,"   satisfactory. 

Practical  considerations  governing  inventory  valuation. — 
While  the  new  decision  gives  every  merchant  the  op- 
tion of  deducting  from  his  taxable  income  any  loss  he 
may  have  sustained  due  to  a  decrease  in  the  market 
value  of  his  merchandise  or  stock  inventory,  it  is  not 
always  advisable  for  the  merchant  to  exercise  this  op- 
tion. It  is  well  to  bear  in  mind  that  the  inventory  fig- 
ure reported  at  the  end  of  one  year  must  be  used  as 
the  inventory  figure  at  the  beginning  of  the  following 
year.  It  is  obvious,  therefore,  that  any  deduction  from 
inventory  valuations  one  year  will  be  reflected  in  the 
following  year's  report,  showing  a  corresponding  in- 
crease in  the  income  for  the  following  year. 


186  INCOME   AND    FEDERAL    TAX   REPORTS 

Therefore,  it  is  often  better  (to  save  taxes  in  a  sub- 
sequent year)  to  value  inventories  at  cost,  even  when 
market  value  is  lower.  Obviously,  this  is  true  when, 
even  if  the  inventories  are  valued  at  cost,  no  profit 
will  be  shown.  The  loss  in  inventory  value  can  then  be 
deducted  in  some  subsequent  year  (when  the  goods  are 
sold  below  the  cost),  and  diminish  the  taxable  profits 
for  that  year. 

Moreover,  if  the  profits  are  small  this  year,  and 
much  larger  profits  are  anticipated  the  following  year, 
it  would  probably  save  super-taxes,  or  excess  profits 
taxes,  in  the  later  year  to  inventory  the  goods  at  cost 
this  year. 

But  if  the  company  cannot  afford  to  pay  much  in 
taxes  this  year,  it  should  inventory  its  goods  at  market 
price  (if  market  price  is  lower  than  cost)  so  as  to  keep 
down  its  taxable  profits  this  year.  The  effect  of  val- 
uing inventories  at  market  price,  when  that  is  lower 
than  cost,  is  to  decrease  taxable  profits  for  the  current 
year,  and  practically  to  increase  taxable  profits  for  a 
future  year. 

From  a  taxpayer's  standpoint  it  is  often  advisable 
to  ask  himself  the  following  question:  "Should  I  in- 
ventory my  goods  at  market  price  (if  market  price  is 
lower  than  cost),  and  thus  save  taxes  this  year,  and 
take  a  risk  on  next  year's  taxes,  or  should  I  inventory 
my  goods  at  cost,  assuming  my  profits  will  be  larger 
or  the  tax  rate  will  be  greater  next  year?" 

Purchases  during  the  year. — The  amount  of  "purchases 
during  the  year"  is  the  gross  price  of  purchases  less 
returns  of  goods  purchased,  and  less  trade  discount 
on  goods  purchased.  Cash  discounts  on  purchases  are 
properly  included  under  "income  from  other  sources." 

A  manufacturing  corporation  may  include  under  pur- 
chases, the  supplies,  etc.,  used  in  manufacturing,  as 
well  as  purchases  of  raw  material.  "Where  supplies 
and  other  items  of  expense  are  included  in  purchases 


CORPORATION    INCOME    TAX  187 

they  should  not  be  included  elsewhere  in  the  report  as 
an  expense. 

Inventory  method  as  applied  to  manufacturing  corpora- 
tions.— In  the  case  of  a  manufacturing  corporation,  the 
inventory  includes  not  only  the  raw  material  purchased 
but  also  the  material  which  is  in  the  process  of  manu- 
facture and  finished  goods.  For  example,  the  gross  in- 
come of  a  manufacturing  corporation  would  be  deter- 
mined as  follows: 

Sales    $50,000.00 

Cost  of  Sales: 

Inventory  at  beginning  of  period: 

Raw  materials   $15,000.00 

Work  in  process 25,000.00 

Finished  stock   10,000.00 

$50,000.00 

Purchases    45,000.00 

Cost    of    manufacturing    or    producing 

goods    10,000.00 

$105,000.00 
Less  inventory  at  end  of  period: 

Raw   material    $10,000.00 

Work  in  process 20,000.00 

Finished  stock    35,000.00 

65,000.00 

Cost  of  goods  sold 40,000.00 

Gross  income  from   operations $10,000.00 

Valuation  of  manufacturers'  inventories. — The  inventory 
of  a  manufacturing  corporation  may  be  divided  into 
three  parts:  raw  materials,  goods  in  process,  and  fin- 
ished goods. 

No  difficulties  need  arise  in  determining  the  cost  of 
raw  materials.  Invoices  or  stock  records  will  furnish 
the  necessary  figures.  Or  if  the  market  value  is  lower 
than  cost,  the  market  value  may  be  used. 

The  difficulties  arise  in  connection  with  goods  in 
process  and  finished  goods.  The  cost  of  a  manufac- 
tured article  is  composed  of  three  elements:  materials, 
labor,  and  overhead.  Prior  to  the  introduction  of  cost 
accounting  the  valuation  of  goods  in  process  and  of 
finished  goods  was  more  or  less  an  estimate.    Material 


188  INCOME   AND    FEDERAL    TAX   REPORTS 

and  labor  were  the  only  items  of  cost  considered. 
Where  cost  accounting  systems  are  in  use,  the  cost  can 
be  accurately  determined,  because  every  article  pro- 
duced is  charged  not  only  with  the  material  used  and 
with  the  labor  expended  upon  it,  but  also  with  a  por- 
tion of  the  expense  of  maintaining  the  factory  and 
other  overhead. 

Overhead  itself  may  be  divided  into  two  classes: 
factory  overhead,  which  includes  the  expenses  incurred 
in  the  operation  of  the  manufacturing  plant,  and  gen- 
eral overhead,  which  includes  all  administrative  and 
selling  expenses.  Only  the  first  class  of  overhead 
should  be  added  to  the  cost  of  the  merchandise  in 
order  to  determine  the  inventory  value  of  the  goods  in 
process  and  the  finished  stock.  General  overhead 
should  properly  be  shown  under  the  separate  captions 
included  under  the  head  of  "General  Expenses." 

The  inventories  of  goods  in  process  and  of  finished 
goods  may  also  be  valued  at  the  market  price,  when 
such  value  is  less  than  the  cost.  As  a  rule  no  market 
exists  for  goods  in  the  process  of  manufacture,  and 
therefore  there  is  no  market  value  of  such  articles.! 
But  a  market  value  may  be  estimated  on  the  basis  o|| 
the  market  value  of  the  items  entering  into  the  goodff 
in  process  and  this  estimated  market  value  may  be 
used  when  it  is  lower  than  the  cost  price. 

Gross  income  of  other  corporations. — Where  the  income 
is  not  directly  related  to  the  amount  of  material  used 
the  gross  receipts  may  be  considered  gross  income, 
and  any  materials  used  may  be  deducted  as  expenses. 
Printers  and  newspaper  publishers,  for  example,  use  a 
considerable  quantity  of  paper,  yet  the  cost  of  the 
paper  is  not  the  determining  factor  of  the  amount  of 
income.  They  are  justified  in  considering  their  gross 
receipts  as  income  and  the  cost  of  paper  used  as  an 
expense  incurred  in  earning  the  income. 

As  was  pointed  out  hereinbefore,  the  law  allows  the 


CORPORATION    INCOME    TAX  lg9 

utmost  freedom  as  to  the  method  of  accounting  to  be 
followed.  The  only  restriction  is  that  the  books  must 
reflect  the  true  income  of  the  corporation. 

The  question  as  to  whether  or  not  certain  items 
should  be  included  as  income  is  very  often  one  of 
accounting  principles  rather  than  one  of  the  interpre- 
tation of  the  law.  The  net  income  of  a  corporation  at 
times  cannot  be  finally  determined  until  all  its  assets 
are  liquidated.  Any  statement  of  net  income  prior  to 
the  liquidation  of  the  affairs  of  the  corporation  is 
necessarily  only  an  estimate.  Accounting  has  devel- 
oped a  number  of  well  recognized  principles  or  rules 
to  be  followed  in  determining  net  income,  and  these 
rules  have  been,  with  one  or  two  exceptions,  accepted 
by  the  Department.  These  principles  and  the  excep- 
tions are  brought  out  in  the  text  where  necessary. 

Take  the  case  of  a  contracting  corporation  which  has 
numerous  uncompleted  contracts  which  in  some  cases 
run  for  periods  of  several  years.  In  this  case  there  is 
no  objection  on  the  part  of  the  Treasury  Department 
to  preparing  a  return  in  such  manner  that  the  gross 
income  will  be  arrived  at  on  the  basis  of  completed 
work,  that  is,  on  contracts  which  have  been  finally 
completed  and  payments  made  during  the  year  for 
which  the  return  is  made.  If  the  gross  income  is 
arrived  at  by  this  method,  the  deductions  or  expenses 
should  be  limited  to  the  expenditures  made  on  account 
of  such  completed  contracts. 

In  all  cases  where  the  gross  income  is  arrived  at  by 
a  method  other  than  the  "inventory"  method,  the  exact 
method  used  should  be  explained  on  the  report. 

Gross  income  of  insurance  companies. — The  income  of 
insurance  companies  is  so  different  from  that  of  the 
ordinary  mercantile  or  trading  corporations  that  the 
Treasury  Department  has  issued  a  special  form  of 
return,  and  has  issued  also  a  number  of  special  regu- 
lations governing  their  return  of  income. 


190  INCOME   AND    FEDERAL    TAX    REPORTS 

Gross  income  of  insurance  companies  consist  of  the 
total  revenue  derived  from  the  operation  of  the  busi- 
ness, including  income,  gains,  or  profits  from  all  other 
sources,  as  shown  by  the  entries  on  the  books  of 
account  within  the  calendar  or  fiscal  year  for  which 
the  return  is  made,  except  as  modified  by  the  express 
exemptions  of  the  articles  which  apply  to  mutual  fire, 
mutual  marine,  and  life  insurance  companies.  The 
return  must  be  made  in  conformity  with  the  reports  for 
the  same  year  made  to  the  Insurance  Department  of  the 
State  in  which  the  company  is  organized. 

Mutual  fire  insurance  companies. — Mutual  fire  insurance 
companies  which  require  their  members  to  make  pre- 
mium deposits  to  provide  for  losses  and  expense,  need 
not  return  as  gross  income  any  portion  of  the  premium 
deposits  returned  to  their  policyholders,  but  should 
return  as  taxable  income  all  income  received  by  them 
from  all  other  sources,  plus  such  portions  of  the  pre- 
mium deposits  as  are  retained  by  the  companies  for 
purposes  other  than  paying  losses  and  expenses  in- 
curred during  the  year  for  which  the  return  is  made 
and  for  such  reinsurance  reserves  as  the  laws  of  the 
State  require. 

Therefore,  if  mutual  fire  insurance  companies  retain 
out  of  moneys  received  on  account  of  assessments  an 
amount  in  excess  of  the  losses,  expenses,  and  reinsur- 
ance reserves  of  any  particular  year,  that  excess,  plus 
amounts  received  from  interest,  dividends,  or  any  other 
source,  will  be  the  net  income  upon  which  the  tax  will 
be  assessed. 

Mutual  marine  insurance  companies. — Mutual  marine  in- 
surance companies  are  required  to  include  as  gross 
income  gross  premiums  collected  less  amounts  paid  by 
them  for  reinsurance.  They  are,  however,  allowed  to  in- 
clude in  deductions  from  gross  income  amounts  repaid 
to  policyholders  on  account  of  premiums  previously  paid 
by  them  and  interest  paid  on  such  unusued  premiums. 


CORPORATION    INCOME    TAX  191 

Life  insurance  companies. — Life  insurance  companies 
are  allowed  to  omit  from  gross  income  "such  portion  of 
any  actual  premium  received  from  any  individual  pol- 
icyholder as  shall  have  been  paid  back  or  credited  to 
the  policyholder  or  treated  as  an  abatement  of  premium 
of  such  individual  policyholder." 

•  Deferred  dividends  payable  at  a  stated  period  and 
representing  a  "portion  of  any  premium  received"  and 
actually  paid  back,  credited  to  the  policyholder  or  ap- 
plied as  an  abatement  of  premium,  may  be  included  in 
the  amount  to  be  omitted  from  gross  income.  Only  the 
amount  credited  or  apportioned  during  the  premium- 
paying  period,  and  not  any  interest  on  such  amounts, 
may  be  excluded  from  gross  income. 

RENTS,  ROYALTIES  AND  INTEREST 

Income  from  rentals. — All  payment  received  in  cash  or 
its  equivalent  as  rent  of  buildings  or  property  owned 
by  the  corporation  must  also  be  reported.  The  rent 
itself  need  not  actually  be  received  directly  by  the  cor- 
poration. For  example,  a  corporation  that  has  leased 
its  properties  in  consideration  of  a  rental  equivalent  to 
a  certain  rate  of  dividend  on  its  outstanding  stock  and 
the  interest  on  its  bonded  indebtedness,  where  such  ren- 
tal is  being  paid  by  the  lessee  directly  to  the  stock  and 
bondholders,  should  make  a  return  of  net  income  show- 
ing the  rental  so  paid  as  having  been  received  by  the 
corporation. 

In  such  cases,  there  are  two  corporations  involved, 
one  the  lessee  and  the  other  the  lessor.  One  is  the  rent 
payer;  the  other  is  the  rent  receiver.  To  the  lessee, 
rental  payments  are  an  expense  of  operation;  to  the 
lessor,  the  rentals  are  an  income. 

Where  a  corporation  leases  property  on  the  condition 
that  a  certain  fixed  sum  be  expended  by  the  tenant  in 
making  improvements,  the  building  or  other  improve- 
ments reverting  to  the  corporation  at  the  termination  of 


192  INCOME    AND    FEDERAL    TAX    REPORTS 

the  lease,  the  value  of  the  improvements  is,  in  reality,  a 
part  of  the  rent  received  by  the  corporation. 

The  value  of  the  improvements  need  not  be  reported 
as  income  until  the  expiration  of  the  lease.  The  gain 
would  be  the  difference  between  the  cost  of  the  im- 
provements and  a  reasonable  allowance  for  deprecia- 
tion during  the  leasehold  period. 

Royalties,  sale  of  patent  rights. — Where  a  corporation 
assigns  the  right  to  manufacture  articles  under  a  pat- 
ent which  it  owns,  in  consideration  of  the  payment  of  a 
fixed  sum  for  each  article  manufactured,  the  payments 
for  the  use  of  the  patent  are  income  to  the  corporation. 
The  corporation  will  be  allowed  to  deduct  from  gross 
income  the  depreciation  in  value  of  the  patent. 

Royalties  from  mines. — Where  a  lessor  corporation  has 
leased  its  mines  on  a  royalty  basis  the  royalty  payments 
represent  both  income  and  a  return  of  principal.  The 
full  amount  of  royalties  received  should  be  included  as 
gross  income,  and  an  amount  deducted  which  represents 
accurately  the  depletion  of  the  mine.1 

Income  from  interest. — All  interest  received,  or  ac- 
crued, if  the  books  of  the  corporation  are  kept  on  an 
accrual  basis,  should  be  reported  as  income,  with  the 
exception  of: 

1.  Interest  on  the  obligations  of  a  State  or  any  po- 
litical subdivision  thereof.2 

2.  Interest  upon  the  obligations  of  the  United  States 
or  its  possessions,  with  the  exception  of  obligations  of 
the  United  States  issued  after  September  1,  1917.2  In- 
terest on  United  States  Liberty  Loan  3y2s  is  therefore 
exempt,  and  need  not  be  reported. 

3.  Securities  issued  under  the  provisions  of  the  Fed- 
eral Farm  Loan  Act  of  July  17,  1916.2 

Second  Liberty  Loan  bonds. — Interest  on  bonds  of  the 
second  Liberty  Loan,  i.e.,   first   or   second  4s,   or   on 

1  See  Chapter  on  Corporation  Deductions,  p.  233,  for  a  full  treatment  of 
depletion. 

2  See  page  39,  ante. 


CORPORATION    INCOME    TAX  193 

Treasury  certificates  of  indebtedness,  is,  by  the  terms 
of  the  act  authorizing  their  issue,  entirely  exempt  from 
the  corporation  income  tax,  but  is  exempt  from  the 
excess  profits  tax  only  to  the  extent  of  the  interest  on 
$5,000  par  value  of  bonds  or  certificates.  As  the  amount 
of  the  excess  profits  tax  is  based  upon  the  net  income 
of  the  corporation  as  shown  by  its  income  tax  return, 
the  interest  on  bonds  of  the  second  Liberty  Loan  should 
be  included  as  income  from  interest,  and  deducted  at  the 
end  of  the  report,  before  computing  the  income  tax. 

For  the  purpose  of  enabling  the  Department  to  verify 
the  returns,  a  supplemental  statement  giving  the  name 
of  the  obligation,  the  amount  of  principal,  the  rate  of 
interest,  and  the  amount  of  interest  received  is  required 
of  all  tax  exempt  securities.    ■ 

Accrued  interest  on  bonds. — Income  from  bonds  should 
include  only  the  interest  earned  from  the  date  of  pur- 
chase. Where  bonds  are  purchased  between  interest 
dates,  the  amount  paid  for  the  accrued  interest  should 
be  deducted  from  the  amount  of  interest  received,  and, 
conversely,  when  bonds  are  sold  between  interest  dates, 
the  amount  received  for  the  accrued  interest  should  be 
reported  as  income.1 

Amortization  of  premium  or  discount  on  bonds. — When 
bonds  are  purchased  for  more  than  their  face  value  the 
amount  of  interest  received  is  not  the  true  income  from 
the  investment.  To  illustrate:  a  6  per  cent  bond  hav- 
ing one  year  to  run  is  purchased  for  $1,030.  The 
amount  of  interest  received  is  $60.  This  is  not  the  true 
income  from  the  bond,  as  at  the  end  of  the  year  the 
holder  receives  only  $1,000,  a  loss  of  $30.  The  true  in- 
come is  $30,  or  slightly  less  than  3  per  cent  on  the  in- 
vestment. 

Where  the  bond  has  several  years  to  run  the  interest 
return  should  be  adjusted  by  writing  off,  or  amortizing, 
as  it  is  technically  called,  the  premium  over  the  life  of 

i  For  illustration,  see  page  68,  ante. 


194  INCOME   AND    FEDERAL    TAX    REPORTS 

the  bond  so  that  at  maturity  the  book  value  of  the  bond 
will  be  the  same  as  its  face  value.  A  rough  method  is 
to  divide  the  premium  by  the  number  of  years  the  bond 
has  to  run  and  deduct  the  resulting  amount  from  the 
book  value  of  the  bond  and  from  the  interest  received 
each  year.  A  more  exact  method,  such  as  is  used  by 
insurance  companies  and  other  large  investors,  is  de- 
scribed in  Sprague's  "Accountancy  of  Investment." 

When  the  bonds  are  purchased  at  a  discount,  that  is, 
for  less  than  their  face  value,  the  circumstances  are  re- 
versed. The  true  income  is  more  than  the  interest  re- 
ceived, because  at  maturity  there  is  received  a  greater 
amount  than  the  cost  of  the  bond.  The  book  value 
should  therefore  be  written  up  or  increased  so  that  it 
agrees  with  the  face  value  of  the  bond  at  maturity.1 

These  increases  or  decreases  in  the  value  of  bonds  as 
they  approach  maturity  are  reflected  in  their  market 
value.  Consequently,  if  a  corporation  is  permitted  to 
inventory  its  securities  at  market  value  when  the  mar- 
ket value  is  less  than  cost  it  cannot,  in  the  case  of  bonds 
purchased  at  a  premium,  amortize  the  reduced  value  of 
the  bond,  as  the  market  value  itself  reflects  the  decrease 
in  value  due  to  approaching  maturity. 

Interest  on  sinking  fund. — Corporations  often  set  aside, 
under  the  control  of  trustees,  a  sinking  fund  to  meet 
their  bonds  as  they  mature.  The  trustees  are  usually 
permitted  to  invest  this  fund  in  the  bonds  of  the  cor- 
poration itself  or  in  bonds  of  other  corporations.  The 
interest  on  the  investments  made  by  the  trustees  is 
considered  taxable  income  in  the  hands  of  the  corpora- 
tion. 

Where  the  fund  has  been  invested  in  its  own  bonds 
a  peculiar  situation  arises.  The  corporation  pays  itself 
interest,  but  may  be  prevented  from  deducting  as  an 
expense  the  interest  it  pays  to  itself,  owing  to  the  lim- 
itation on  the  amount  of  interest  which  may  be  deducted 

i  For  illustration,  see  page  69,  ante. 


CORPORATION    INCOME    TAX  195 

(see  chapter  on  Corporation  Income  Deductions,  page 
243)  and  yet  be  required  to  include  the  interest  as 
income. 

It  seems  to  the  author  that  the  only  fair  thing  to  do 
would  be  to  exclude  such  interest  both  from  the  income 
side  and  from  the  deduction  side  of  the  report,  but  this 
view  is  not  taken  by  the  Treasury  Department.  The 
difficulty  may  be  overcome  and  an  equitable  adjustment 
by  the  turning  in  by  the  trustees  of  the  bonds  pur- 
chased, so  that  they  may  be  cancelled  by  the  corpora- 
tion. There  is  then  no  occasion  for  the  corporation  to 
pay  itself  interest. 

DIVIDENDS  RECEIVED 

Income  from  dividends. — All  dividends  received  should 
be  included  as  income,  regardless  of  the  fact  that  the 
corporation  declaring  the  dividend  has  been  taxed  on  its 
net  income. 

Dividends,  however,  are  subject  only  to  the  2  per 
cent  tax  imposed  by  the  act  of  September  8,  1916,  and 
not  to  the  additional  tax  of  4  per  cent  imposed  by  the 
act  of  October  3,  1917.  The  entire  amount  of  dividends 
should  be  included  as  gross  income,  the  adjustment  be- 
ing made  in  the  calculation  of  the  tax.  Inasmuch  as  the 
earnings,  from  which  these  dividends  have  been  paid, 
have  already  been  subjected  to  a  2  per  cent  tax,  the 
payment  of  the  2  per  cent  tax  by  the  recipient  of  the 
dividend  results  in  double  taxation  to  that  extent. 

No  dividends  paid  out  of  earnings  or  profits  accumu- 
lated prior  to  March  1,  1913,  are  taxable  as  income  in 
the  hands  of  the  recipient.  This  exemption  applies 
only  to  dividends  received  subsequent  to  January  1, 
1916,  as  the  law  of  October  3,  1913,  which  was  in  force 
until  that  date,  did  not  contain  any  exemption  for  divi- 
dends paid  out  of  earnings  accumulated  prior  to  March 
1,  1913. 

The  action  of  the  Treasury  Deparment  in  taxing  such 


196  INCOME   AND    FEDERAL    TAX    REPORTS 

dividends  during  the  years  1913,  1914  and  1915  was 
upheld  by  the  United  States  Circuit  Court  of  Appeals, 
in  Lewellyn  vs.  Gulf  Oil  Corporation  (decided  October 
19,  1917).1 

The  rules  for  determining  in  what  year  or  years  the 
surplus  distributed  by  a  dividend  was  earned,  apply 
equally  to  corporations  and  to  individuals.  The  rules 
may  be  summarized  as  follows : 

Dividends  paid  between  Jan.  1,  1917,  and  August  5,  1917. 
— Any  dividends  paid  in  1917  prior  to  August  6th  may 
be  declared  by  the  paying  corporation  to  be  out  of  sur- 
plus accumulated  prior  to  March  1,  1913.  If  not  so  de- 
clared they  will  be  treated  as  being  paid  out  of  the 
most  recently  accumulated  surplus. 

Dividends  paid  on  and  after  August  6,  1917. — All  divi- 
dends paid  on  and  after  August  6,  1917,  will  be  treated 
as  having  been  paid  out  of  the  most  recently  accumu- 
lated surplus. 

Dividends  are  taxable  at  the  rates  in  effect  for  the 
year  in  which  the  surplus  out  of  which  they  are  de- 
clared was  earned.  Although  corporations  have  been 
taxed  on  the  basis  of  their  net  income  since  January  1, 
1909,  the  income  subject  to  tax  in  the  period  from  Janu- 
ary 1,  1909  to  January  1,  1913,  did  not  include  any  in- 
come from  dividends;  therefore,  corporations  have  been 
taxed  on  dividends  received  only  since  January  1,  1913. 
And  any  dividends  declared  out  of  earnings  accumulated 
prior  to  March  1,  1913,  would  not  be  taxable  even 
though  the  specific  exemption  were  not  in  the  1909  law. 

In  considering  the  rates  of  tax  on  dividends  received 
by  a  corporation  we  must  consider  three  periods: 

Prior  to  March  1,  1913 no  tax 

March  1, 1913  to  December  31, 1915 . .  1  per  cent 
January  1,  1916  to  date   2  per  cent 

i  For  the  possible  effect  of  this  decision,  as  to  stock  dividends,  see 
Chapter  on  Income  from  Dividends,  Individuals,  pp.  87-98. 


CORPORATION    INCOME    TAX  197 

Where  a  rate  of  tax  other  than  that  in  effect  at  the 
time  of  making  the  return  is  used,  a  statement  should 
be  attached  to  the  return  showing  all  the  facts  necessary 
to  support  the  use  of  the  lower  rate. 

Dividends  received  out  of  earnings  prior  to  March 
1,  1913,  need  not  be  included  as  income,  but  mention 
should  be  made  on  the  return  of  the  fact  that  they  have 
been  received  and  the  reason  for  not  including  them 
should  be  given. 

Dividends  of  Federal  reserve  banks. — Dividends  on  the 
stock  of  Federal  reserve  banks  are  exempt.  It  is  held 
that  the  exemption  provided  for  in  the  Federal  Keserve 
act  follows  the  dividend  into  the  hands  of  the  member 
banks  holding  the  Federal  Reserve  bank  stock. 

Profits  of  subsidiary  companies  considered  dividends  to 
parent  company. — The  Treasury  Department  holds  (T.  D. 
2137),  that  "in  a  case  wherein  a  holding  company  actually 
takes  up  each  month  on  its  books  its  proportionate  share 
of  the  earnings  of  the  underlying  companies,  such  holding 
company  will  be  required  to  include  in  its  gross  income 
the  amounts  thus  taken  up  regardless  of  the  fact  that 
the  same  may  not  have  been  actually  paid  to  it  in  cash. 
The  fact  that  the  underlying  companies  credit  to  the 
holding  company  the  amount  of  earnings  to  which  it  is 
entitled  on  the  basis  of  the  stock  it  holds,  together  with 
the  fact  that  the  holding  company  takes  up  on  its  books 
the  amount  thus  credited,  renders  it  incumbent  upon 
the  holding  company  to  return  these  amounts  as  in- 
come, regardless  of  the  fact  that  the  underlying  com- 
panies needed  these  earnings  and  used  them  in  making 
extensions  and  improvements  and  in  furtherance  of  their 
business." 

The  author  does  not  see  how  this  Treasury  decision 
can  be  reconciled  with  the  Department's  attitude  that 
unrealized  or  book  profits  are  not  to  be  considered 
income,  or  with  the  decision  of  the  United  States  Dis- 
trict Court  in  Southern  Pacific  Company  vs.  Loive,  in 


198  INCOME   AND    FEDERAL    TAX   REPORTS 

which  Judge  Manton  stated  that  "although  the  South- 
ern Pacific  held  all  the  stock  of  the  subsidiary  and  had 
actual  possession  of  the  moneys,  it  did  not  become 
legally  entitled  to  the  earnings  of  the  subsidiary  until 
such  dividends  were  declared  by  the  subsidiary."  x 

SPECIAL   SOURCES   OF  INCOME 

Gross  income — other  sources. — Income  not  covered  un- 
der any  of  the  headings  already  discussed  should  be 
included  as  income  from  other  sources.  Each  item 
should  be  listed  separately,  with  the  source  and  the 
amount  of  the  income. 

Recoveries  on  bad  debts. — Money  received  on  accounts 
previously  charged  off  as  bad  debts  should  be  reported 
as  income  regardless  of  the  date  when  such  accounts 
were  charged  off. 

Assessment  paid  by  stockholders  not  income  to  corpora- 
tion.— Assessments  made  against  the  stockholders  of  the 
corporation  are  considered  payments  on  account  of  the 
capital  stock  issued  and  are  not  considered  as  income. 
Likewise,  voluntary  assessments  paid  by  the  stock- 
holders are  considered  as  additional  payment  for  the 
capital  stock,  and  not  as  income. 

Corporation's  compromise  of  indebtedness. — In  a  case 
where  a  creditor  legally  releases  a  debtor  corporation 
from  part  of  a  debt,  the  amount  of  such  debt  released 
constitutes  income,  because  the  liability  of  the  corpora- 
tion is  reduced  and  the  net  worth  has  correspondingly 
increased. 

Reducing  of  bonded  indebtedness. — Where  a  corporation 
in  a  reorganization  takes  over  its  own  bonds  in  ex- 
change for  other  securities  and  cash  at  less  than  the 
face  value   of  the  bonds,   the   difference  between  the 

i  In  view  of  this  decision  of  the  court,  it  appears  that  such  corporations 
should  report  as  income  from  dividends  only  the  income  or  earnings  of  the 
subsidiary  which  have  actually  been  declared  as  dividends  and  as  such 
paid  over  to  the  holding  company. 


CORPORATION    INCOME    TAX  199 

value  at  which  the  bonds  were  taken  up  by  the  corpora- 
tion and  their  face  value  would  be  income.  This  income 
should  be  prorated  as  between  the  period  prior  to 
March  1,  1913  and  the  period  subsequent  to  that  date, 
on  the  basis  of  the  number  of  years  the  bonds  had  run. 
That  part  which  was  apportioned  to  the  period  subse- 
quent to  March  1,  1913,  would  be  income  for  the  year 
in  which  the  bonds  were  redeemed,  and  taxable  at  the 
rate  in  effect  for  the  year.1 

Sale  by  corporation  of  its  assets  in  consideration  of  stocks 
or  bonds  of  the  purchasing  corporation. — The  profit,  if  any, 
realized  by  a  corporation  in  the  sale  of  its  assets  to 
another  corporation  in  consideration  of  stocks  or  bonds 
of  the  purchasing  corporation,  would  be  the  amount 
received  from  the  purchasing  corporation  which  is  in  ex- 
cess of  the  sum  of  the  fair  market  price  or  value  on 
March  1,  1913,  of  that  part  of  the  assets  that  were 
owned  on  March  1,  1913  and  the  cost  price  of  that  part 
of  the  sold  assets  acquired  since  March  1,  1913.  In  the 
absence  of  a  definitely  known  or  established  market 
price  of  the  value  of  the  assets  of  the  selling  corpora- 
tion, as  of  March  1,  1913,  it  should  ascertain  as  nearly 
as  possible,  what  the  value  of  the  assets  was  as  of  that 
date,  taking  into  consideration,  in  addition  to  its  capital 
invested,  surplus  and  undivided  profits,  and  the  value  of 
any  of  its  intangible  assets.    The  difference  between  the 

i  In  cases  similar  to  the  above  the  Treasury  Department  has  sometimes 
ruled  that  the  dividing  date  between  taxable  and  non-taxable  income  is 
January  1,  1909,  the  effective  date  of  the  Corporation  Excise  Tax.  The 
act  of  August  5,  1909,  imposed  a  tax  on  the  net  income  of  corporations 
for  the  calendar  years  1909  to  1912  inclusive.  This  tax,  even  though 
based  on  net  income  was  not  an  income  tax.  It  was  a  tax  levied  on  the 
franchise  of  the  corporation  for  the  privilege  of  doing  business  and  the 
net  income  of  the  corporation  was  used  as  the  measure  of  the  value  of  the 
franchise.  Having  paid  this  franchise  tax  the  corporation  should  not  be 
compelled  to  pay  an  additional  tax  on  account  of  income  received  in  sub- 
sequent years,  but  which  is  held  to  have  been  earned  in  the  period  covered 
by  the  franchise  tax.  The  division  suggested  in  the  text  above  is  therefore 
correct. 


200  INCOME   AND    FEDERAL    TAX   REPORTS 

sum  of  the  fair  market  value  and  the  price  so  deter- 
mined, and  the  par  value  of  the  stock  and  bonds  of  the 
purchasing  corporation,  which  will  be  assumed  in  the 
absence  of  any  proof  to  the  contrary  to  be  worth  par, 
will,  for  income  tax  purposes,  be  returned  as  taxable 
income. 

The  following  case  will  serve  to  illustrate  the  above 
rule: 

Corporation  A 

Assets  sold,  which  were  owned  on  March  1, 
1913:  market  value  of  such  assets  as  of 
March  1,  1913  $100,000 

*Assets  sold,  which  were  acquired  since  March 
1,  1913:  cost  price  of  such  assets  at  time 
of  purchase  by  Corporation  A  200,000 

Total  sum  of  above  $300,000 

Stocks  and  bonds  of  purchasing  corporation 
received  by  Corporation  A  in  payment  of 
above  property   $350,000 

Profit  of  Corporation  A  (the  selling  corpora- 
tion    $50,000 

Sales  of  bonds  at  a  premium. — When  a  corporation  is- 
sues its  bonds  for  more  than  their  face  value  a  book 
profit  results.  This  apparent  profit  is  really  a  present 
receipt  of  money  by  the  corporation,  for  its  agreement 
to  pay  a  larger  rate  of  interest  in  future  years.  The 
corporation  could  have  sold  bonds,  bearing  interest  at 
a  lower  rate,  at  par  and  saved  the  larger  interest  pay- 
ments in  future  years.  This  advance  payment  for  in- 
terest, or  the  premium,  should  not  be  included  in  full  as 
income  for  the  year  in  which  it  was  received,  but  should 
be  distributed  over  the  life  of  the  bonds.    The  same 

*  In  the  above  assets  there  should  not  be  included  any  mere  book  appre- 
ciation of  assets  acquired  either  subsequent  or  prior  to  March  1,  1913. 


CORPORATION    INCOME    TAX  201 

rule  applies  to  discount  on  bonds.  The  amount  of  dis- 
count should  not  be  deducted  in  one  lump  sum  but 
should  be  spread  over  the  life  of  the  bond. 

Proceeds  of  life  insurance. — When  the  corporation  pays 
premiums  on  insurance  policies,  which  are  made  pay- 
able to  the  corporation,  upon  the  lives  of  officers  or 
others,  the  proceeds  of  the  policies,  less  the  premiums 
paid  (excluding  such  premiums  as  may  have  been  prev- 
iously been  deducted),1  must  be  reported  by  the  cor- 
poration as  income  for  the  year  in  which  the  proceeds 
were  received.  It  makes  no  difference  whether  the 
proceeds  are  received  at  the  end  of  a  specified  time,  as 
in  an  endowment  policy,  or  upon  the  death  of  the  in- 
sured. 

Apparently  the  reason  for  this  rule  is  to  prevent  a 
corporation  from  paying  out  large  amounts  in  insurance 
premiums,  in  years  when  taxes  are  high,  to  obtain  the 
return  of  the  premiums  (in  the  form  of  the  principal  of 
the  policies)  upon  the  death  of  the  persons  insured  or 
at  specified  future  dates  in  years  when  taxes  may  be 
low. 

This  reason,  however,  does  not  apply  to  premiums 
paid  on  time  policies  on  lives  of  officers  or  employees. 
In  this  case  there  is  no  assurance  that  the  corporation 
will  ever  obtain  a  return  of  premiums  paid,  for  there 
is  only  a  mere  possibility  of  the  officers  or  employees 
dying  during  the  term  of  a  time  policy.  While  there 
has  been  no  Treasury  Department  ruling  on  this  point, 
it  would  seem  that  premiums  paid  on  time  policies  are 
deductible.  Such  premiums  are  undoubtedly  a  neces- 
sary expense  of  the  business,  for  they  protect  the  busi- 

i  The  old  ruling  of  the  Department  was  that  premiums  paid  were  de- 
ductible as  an  expense  and  that  maturing  policies  should  be  returned  as 
income  in  full.  Under  the  new  regulations,  as  stated  above,  premiums 
paid  are  not  deductible  as  an  expense  but  are  allowed  as  a  credit  towards 
the  amount  received  at  maturity  of  the  policy. 

Premiums  previously  deducted  as  an  expense  should  not  again  be  de- 
ducted at  the  maturity  of  the  policy. 


202  INCOME   AND   FEDERAL   TAX   REPORTS 

ness  against  sudden  losses  that  the  business  might 
sustain  through  the  death  of  an  individual  officer.  In 
some  cases  the  success  of  the  business  depends  on  the 
activity  of  one  individual,  and  insurance  on  his  life  is 
almost  an  indispensable  expense.  In  the  case  of  these 
"one  man"  concerns,  some  of  its  creditors  refuse  to 
extend  credit  to  it  unless  insurance  is  carried  in  the 
life  of  that  man,  and  moreover  the  carrying  of  business 
life  insurance  strengthens  the  credit  standing  of  the 
concern  in  many  cases  as  much  as  does  the  carrying  of 
fire  insurance.  For  these  reasons,  premiums  paid  on 
time  policies  on  the  lives  of  employees  or  officers  of  a 
corporation,  where  the  loss  is  payable  to  the  employer, 
should  be  an  allowable  deduction  from  income. 

Appreciation  in  value  of  capital  assets. — Appreciation 
in  the  value  of  capital  assets,  even  though  evidenced  by 
an  entry  upon  the  books  of  the  corporation,  is  not  in- 
come until  the  appreciation  has  been  converted  into 
cash  or  its  equivalent.  It  is,  therefore,  unnecessary  to 
report  any  such  appreciation  until  the  property  is  sold. 

On  the  other  hand,  no  decreases  in  value,  excepting 
allowances  for  depreciation  and  depletion,  may  be  de- 
ducted until  the  loss,  as  the  result  of  a  closed  transac- 
tion, has  been  definitely  ascertained. 

Appreciation  of  good-will. — A  surplus  created  by  plac- 
ing good-will  upon  the  books  of  a  corporation  or  in- 
creasing the  value  of  the  good-will  already  on  the  books 
is  not  taxable  income. 

Sale  of  capital  assets. — The  profit  resulting  from  the 
sale  of  a  capital  asset  is  the  difference  between  its  cost, 
if  it  was  purchased  subsequent  to  March  1,  1913,  or  the 
market  value  as  of  March  1,  1913,  if  purchased  prior  to 
that  date,  and  the  selling  price  when  the  selling  price 
is  greater  than  the  cost. 

The  market  value  as  of  March  1,  1913,  may  be  es- 
tablished in  any  manner  which  results  in  the  determin- 
ing of  a  "fair  market  price." 


CORPORATION    INCOME   TAX  203 

In  the  case  of  securities  listed  on  an  exchange,  the 
average  quotations  for  March  1,  1913,  would  be  accepted 
as  the  "fair  market  price." 

In  the  case  of  real  estate,  an  appraisal  made  within 
a  reasonable  time  of  March  1,  1913,  would  be  acceptable. 

The  assessed  value  of  real  estate  may  be  used,  but 
where  the  average  assessed  value  of  property  in  the  dis- 
trict does  not  represent  the  market  value,  an  adjustment 
should  be  made.  To  illustrate,  a  piece  of  real  estate 
was  assessed  in  October,  1912,  at  $60,000.  In  January, 
1913,  a  piece  of  property  in  the  same  district,  assessed 
at  $12,000,  was  sold  for  $20,000,  and  another  plot  as- 
sessed at  $18,000  was  sold  for  $30,000.  These  two  sales 
would  indicate  that  property  in  the  district  was  assessed 
at  about  60  per  cent  of  its  market  value.  The  market 
value  in  October,  1912,  of  the  property  which  was  as- 
sessed at  $60,000  would  be  $100,000,  which  figure  could 
be  used  as  the  fair  market  value  on  March  1,  1913. 

If  it  is  not  practicable  otherwise  to  establish  the 
market  price  on  March  1,  1913,  the  apportionment  of 
the  entire  sum,  i.e.,  the  difference  between  cost  and 
selling  price,  over  the  period  the  asset  was  owned  would 
help  determine  the  "fair  market  price"  as  of  March  1, 
1913.  To  illustrate:  A  purchases  property  March  1, 
1910,  for  $5,000  and  sells  the  property  March  1,  1917, 
for  $19,000.  If  there  is  no  other  practicable  means  of 
determining  the  value  as  of  March  1,  1913,  the  gain  of 
$14,000  may  be  apportioned  over  the  entire  period  the 
property  was  owned.  Thus,  three-sevenths  of  the  in- 
crement, or  $6,000,  would  be  regarded  as  having  accrued 
prior  to  March  1,  1913,  and  four-sevenths,  or  $8,000, 
since  that  date.  This  would  tend  to  show  that  the  value 
on  March  1,  1913,  was  $11,000,  and  that  only  $8,000  of 
the  gain  is  taxable.  Of  course,  if  any  of  the  other 
methods  mentioned  above  could  be  used,  this  method 
would  not  be  permitted. 

In  all  cases,  a  statement  should  be  attached  to  the 


204  INCOME   AND    FEDERAL    TAX   REPORTS 

return  showing  how  the  fair  value  as  of  March  1,  1913, 
was  determined. 

The  use  of  the  market  value  of  March  1,  1913,  works 
a  hardship  in  cases  where  that  value  is  less  than  the 
original  cost.  To  illustrate:  a  piece  of  real  estate  is 
purchased  in  1909  for  $50,000.  The  market  value  March 
1,  1913,  is  $35,000.  In  April,  1917,  it  is  sold  for  $45,000. 
The  difference  between  $45,000  and  $35,000,  or  $10,000, 
must  be  reported  as  income  for  1917.  As  a  matter  of 
fact,  the  net  loss  on  the  transaction  is  $5,000,  but  the 
corporation  is  not  allowed  any  credit  for  the  loss  in  the 
period  from  1909  to  March  1,  1913.  The  Department 
is  justified  in  its  attitude,  on  the  ground  that  the  tax 
for  the  period  from  January  1,  1909,  to  March  1,  1913, 
was  not  an  income  tax,  and  that  the  Income  Tax  law 
levies  a  tax  upon  all  income  and  profits  earned  or  ac- 
crued since  March  1,  1913,  and  that  the  difference  be- 
tween the  value  as  of  March  1,  1913,  and  the  selling 
price  is  the  measure  of  such  profit  as  provided  by  the 
law. 

Where  real  estate  is  purchased  subsequent  to  March 
1,  1913,  there  may  be  added  to  the  original  cost  all 
special  assessments  paid  for  local  benefits  in  connection 
with  the  property,  and  such  carrying  charges  as  have 
not  been  deducted  in  a  report  of  net  income  made  in 
the  year  in  which  it  was  purchased  or  in  subsequent 
years. 

Property  purchased  for  capital  stock. — In  cases  where 
property  is  taken  over  in  exchange  for  capital  stock  of 
the  corporation  at  a  par  value  greatly  in  excess  of  the 
true  value  of  the  property,  the  transaction  may  be 
ignored  as  establishing  the  cost  of  the  property,  and 
the  actual  value  of  the  property  at  the  time  of  acquisi- 
tion may  be  considered  as  its  cost. 

The  same  rule  may  be  followed  where  the  property  is 
taken  over  at  a  nominal  figure.  The  true  value  of  the 
property  at  the  time  of  its  acquisition  may  be  consid- 


CORPORATION    INCOME    TAX  205 

ered  as  the  cost,  and  the  difference  between  this  figure 
and  the  selling  price  reported  as  profit. 

In  all  snch  cases  the  value  placed  upon  the  property 
is  subject  to  the  approval  of  the  Bureau  of  Internal 
Eevenue,  and  in  making  the  return  a  statement  should 
be  attached  showing  the  amount  paid  for  the  property, 
and  the  method  used  in  arriving  at  the  true  value. 

Other  forms  of  income. — The  calculation  of  income 
from  stock  transactions  and  other  transactions  is  dis- 
cussed at  length  under  the  "Individual  Return"  on 
pages  59-66. 


CHAPTER  IX 

INCOME  TAX  ON  CORPORATIONS 

DEDUCTIONS 

Deductions  from  gross  income. — A  payment  of  cash  or 
its  equivalent  made  by  a  corporation  results  in  either 
(1)  an  increase  in  some  asset  (or,  what  is  practically 
the  same,  a  decrease  in  liabilities),  or  (2)  a  decrease 
of  the  income  for  the  period.  Expenses  may  be  di- 
vided therefore  into  capital  expenses  and  income  ex- 
penses. Capital  expenses  add  to  the  value  of  some 
asset  and  are  not  deductible  from  gross  income.  In- 
come expenses  are  those  expenses  which  are  incurred 
in  connection  with  the  earning  of  the  gross  income  and 
which  are  a  proper  deduction  in  determining  net  in- 
come. 

The  Income  Tax  law  recognizes  this  distinction  be- 
tween charges  against  capital  and  charges  against  in- 
come and  does  not  permit  the  deduction  of  any  capital 
expenditures.  The  law  also  places  some  arbitrary  lim- 
its upon  the  deduction  of  certain  items  of  expense, 
which  are  considered  by  business  men  as  ordinary  ex- 
penses of  the  business.    These  will  be  referred  to  later. 

The  deductions  allowed  by  the  law  may  be  divided 
into  four  classes:  ordinary  and  necessary  expenses  of 
business;  losses,  including  depreciation  and  depletion; 
interest  paid;  and  taxes.  These  will  be  discussed  in 
the  order  mentioned. 

ORDINARY  AND  NECESSARY  EXPENSES  OP  THE  BUSINESS 

Ordinary  and  necessary  expenses  of  the  business. — The 
Income  Tax  law,  sec.  12,  subdivision  (a),  provides  for 
the  deduction  of: 

206 


INCOME    TAX   ON    CORPORATIONS  207 

"All  the  ordinary  and  necessary  expenses  paid  within 
the  year  in  the  maintenance  and  operation  of  its  busi- 
ness and  properties,  including  rentals  or  other  pay- 
ments required  to  be  made  as  a  condition  to  the  con- 
tinued use  or  possession  of  property  to  which  the  cor- 
poration has  not  taken  or  is  not  taking  title,  or  in 
which  it  has  no  equity." 

Cash  or  accrued  expenses. — The  law  provides  for  the 
deduction  only  of  such  expenses  as  are  paid  within  the 
year.  But,  inasmuch  as  the  law  permits  the  keeping 
of  accounts  on  some  other  than  a  cash  basis,  any  ex- 
pense charged  upon  the  books  may  be  deducted,  even 
though  it  has  not  been  paid,  provided  the  gross  income 
of  the  corporation  is  reported  in  the  same  manner. 
Such  accrual  items  should  not  again  be  deducted  when 
they  are  paid,  nor  should  any  item  of  expense  be  de- 
ducted here,  if  it  has  been  included  elsewhere  as  cost 
of  merchandise  and  credited  against  gross  income. 

Prepaid  expenses. — Where  accounts  are  kept  on  a  cash 
basis  all  expenses  paid  during  the  year,  whether  for  the 
present,  a  past  or  a  future  period,  should  be  deducted. 
Where  accounts  are  kept  on  an  accrual  basis,  only  such 
expenses  as  are  applicable  to  the  period  for  which  the 
income  tax  report  is  rendered  should  be  deducted. 
Therefore,  if  insurance  premiums  are  paid  for  a  policy 
for  two  years,  only  that  part  of  the  premiums  repre- 
senting amounts  paid  for  protection  during  the  present 
period  should  be  deducted. 

The  same  rule  applies  to  prepayment  of  taxes.  Only 
so  much  of  the  taxes  as  are  for  the  present  period 
should  be  deducted.  Taxes  paid  in  the  present  period 
for  future  periods  should  be  carried  on  the  books  as  a 
deferred  asset,  and  charged  off  as  expense  in  the  future 
periods. 

Payments  in  advance  for  contracts  to  be  completed 
over  a  period  of  years,  and  all  other  prepaid  expenses, 
should  be  treated  in  the  same  way. 


208  INCOME    AND    FEDERAL    TAX    REPORTS 

Payments  of  expenses  need  not  be  in  cash. — The  pay- 
ments for  expenses  need  not  be  made  in  cash.  They 
may  be  made  in  merchandise,  stock,  or  any  other  asset. 
In  this  case,  the  actual  value  of  the  asset  may  be  de- 
ducted as  an  expense.  For  example,  the  value  of  stock 
paid  to  officers  as  salary  would  be  a  deductible  ex- 
pense. 

Capital  stock  paid  for  a  contract. — The  value  of  cap- 
ital stock  of  a  corporation  that  is  given  in  considera- 
tion of  a  contract  is  a  deductible  expense  of  the  cor- 
poration giving  the  stock,  but  the  expense  should  be 
prorated  over  the  life  of  the  contract,  either  on  a  per 
year  basis  or  on  a  per  unit  basis.  Thus,  if  a  corpora- 
tion gives  $1,000  worth  of  stock  for  a  contract  that 
will  run  over  a  period  of  five  years,  the  corporation 
may  deduct  as  an  expense  $200  during  each  of  the  five 
years.  This  $200  represents  the  amount  paid  in  ad- 
vance for  one  year  of  the  contract.  If  the  contract  is 
to  produce  a  certain  number  of  units,  even  though  the 
contract  will  run  over  a  definite  period  of  years,  it 
would  be  better  and  more  scientific  to  deduct  each  year 
that  part  of  the  cost  of  the  contract  represented  by  the 
ratio  of  the  value  of  units  manufactured  to  value  of 
the  total  units  to  be  produced  under  the  contract.  Thus, 
if  a  corporation  pays  $1,000  worth  of  stock  for  a  con- 
tract calling  for  the  manufacture  of  10,000  rifles  at  $100 
each,  in  five  years;  4,000  to  be  manufactured  the  first 
year,  3,000  the  second,  and  1,000  the  third,  fourth  and 
fifth  years,  the  corporation  should  deduct  as  an  expense 
of  obtaining  the  contract  $400  the  first  year,  $300  the 
second,  and  $100  the  third,  fourth  and  fifth  years. 

The  value  of  the  stock  should  be  determined  by  as- 
certaining what  was  the  actual  value  at  the  time  of  the 
transfer  of  the  stock,  or  what  amount  it  could  have 
been  sold  for  in  cash  or  its  equivalent  at  the  time  of 
delivery. 

Salaries,  wages  and  commissions. — All  payments  for  sal- 
aries of  employees,  wages  and  commissions  should  be 


INCOME    TAX    ON    CORPORATIONS  209 

deducted.  Salaries  of  officers  of  the  corporation  should 
be  shown  under  a  separate  caption  irrespective  of  the 
amount  so  paid.  The  salary  or  commission  may  be 
paid  in  stock  of  the  corporation,  in  which  case  the  de- 
duction would  be  the  actual  value  of  the  stock  so  given, 
provided  such  amount  was  charged  as  an  expense  on 
the  books  of  the  corporation  at  the  actual  value  of  such 
stock. 

Salary  to  be  deducted  must  be  actually  entered  upon 
the  books  as  an  expense  of  business,  and  if  the  cor- 
poration renders  its  return  of  income  upon  the  cash 
basis  such  salary,  to  constitute  a  proper  deduction, 
must  not  only  be  entered  upon  the  books  of  the  corpora- 
tion as  an  expense  but  must  also  be  actually  paid  in 
cash  to  the  recipient.  But  if  the  corporation  renders 
its  returns  on  the  accrual  basis,  the  corporation  would 
include  as  an  expense  the  amount  representing  the  sal- 
ary accrued.  Even  in  this  latter  case,  if  the  individual 
made  his  report  on  a  cash  basis,  he  would  report  the 
salary  as  income  only  in  the  year  in  which  it  was  actu- 
ally paid  to  him  by  the  corporation. 

Salaries  of  officers  and  employees  who  are  stockholders 
of  the  corporation. — Salaries  of  officers  or  employees, 
who  are  stockholders  or  who  have  an  interest  in  the 
business,  will  be  subject  to  careful  analysis,  and  if  they 
are  found  to  be  rather  in  proportion  to  the  stock  hold- 
ings or  interest  of  such  officers  and  employees  than  to 
the  real  value  of  the  services  rendered,  and  to  be  in 
excess  of  the  salaries  paid  to  officers  or  employees  in 
similar  positions  in  other  concerns  doing  business  of 
a  like  nature  and  of  approximately  equal  volume  and 
earnings,  the  amount  paid  in  excess  of  reasonable  com- 
pensation for  the  services  will  not  be  deductible  from 
gross  income,  but  will  be  treated  as  a  distribution  of 
profits.    (T.  D.  2616.) 

Where  any  payment  to  an  officer  or  other  stockholder 
of  a  corporation  is  held  by  the  Treasury  Department 


210        INCOME   AND    FEDERAL    TAX   REPORTS 

to  be  a  distribution  of  profits,  such  payment  should  be 
treated  by  the  individual  receiving  it  as  a  dividend 
from  the  corporation. 

The  author  is  aware  of  a  number  of  cases  where  an 
additional  tax  has  been  assessed  against  a  corporation 
on  the  ground  that  certain  payments  to  its  officers  were 
a  distribution  of  profits  and  not  compensation  for  serv- 
ices, in  which  cases  adjustment  was  then  made  on  the 
individual  returns  of  the  officers  to  reflect  such  income 
as  a  dividend,  which  in  fact  it  was. 

Salaries  of  soldiers. — Where  a  corporation  continues 
to  pay  an  employee  his  salary  during  his  service  in  the 
United  States  Army,  it  will  be  considered  a  necessary 
expense  of  the  operation  of  the  business  and  may  be 
deducted. 

Pensions. — Amounts  paid  for  pensions  to  retired  em- 
ployees or  those  dependent  upon  them  for  support,  in- 
cluding their  families,  or  pensions  paid  on  account  of 
injuries  received  by  employees,  are  proper  deductions 
as  ordinary  and  necessary  expenses  of  the  business. 

A  monthly  salary  paid  to  the  widow  of  a  former  em- 
ployee for  a  limited  period  in  recognition  of  the  services 
of  the  deceased  husband,  no  services  being  rendered  by 
the  widow,  is  held  to  be  a  gratuity  and  is  not  an  allow- 
able deduction  from  gross  income. 

Gifts,  gratuities  and  bonuses. — As  gifts  received  by  an 
individual  are  not  taxable,  the  corporation  making  the 
gift  is  not  allowed  to  deduct  gifts  to  its  employees. 
Gifts  to  customers,  such  as  souvenirs,  would  be  con- 
sidered a  necessary  expense  of  advertising  the  business, 
and  allowed  as  a  deduction. 

The  attitude  of  various  internal  revenue  officers  on 
the  question  of  bonuses  varies  greatly,  because  of  the 
latitude  allowed  them  by  the  regulations  contained  in 
Letter  1314  to  collectors,  which  reads  as  follows: 

"Special  payments  made  by  a  corporation  as  extra 
compensation  to  certain  of  its  employees,  may  be  de- 


INCOME    TAX   ON    CORPORATIONS  211 

ducted  from  gross  income  if  it  is  clearly  shown  that 
such  payments  are  made  as  compensation  for  services 
rendered,  and  paid  in  pursuance  of  a  contract  express 
or  implied.  But  if  there  is  no  contractual  relation  be- 
tween the  employer  and  the  employees  by  which  the 
employee  could  enforce  his  claim  for  additional  com- 
pensation, the  payments  would  be  considered  as  pay- 
ments of  gratuities  and  as  such  are  not  an  allowable 
deduction." 

This  ruling,  which  made  every  corporation  act  as  a 
judge  in  determining  whether  or  not  a  contract  existed 
between  itself  and  employees,  has  been  modified  by 
T.  D.  2616,  which  reads  as  follows: 

"In  order  to  establish  uniformity  and  to  facilitate 
the  work  of  internal  revenue  officers  who  are  engaged 
in  the  examination  of  books  for  the  verification  of  re- 
turns of  annual  net  income  made  pursuant  to  the  re- 
quirements of  the  Federal  Income  Tax  Law,  you  are 
informed  that  special  payments,  sometimes  denominated 
gifts  or  bonuses,  made  by  corporations,  partnerships,  or 
individuals  to  officers  or  employees,  will  constitute  al- 
lowable deductions  from  gross  income  in  ascertaining 
net  income  for  the  purpose  of  the  income  tax,  when 
such  payments  are  made  in  good  faith  and  as  addi- 
tional compensation  for  the  services  actually  rendered 
by  the  officers  or  employees.  If  such  payments,  when 
added  to  the  stipulated  salaries,  do  not  exceed  a  rea- 
sonable compensation  for  the  services  rendered,  they 
will  be  regarded  as  a  part  of  the  wage  or  hire  of  the 
officer  or  employee,  and  therefore  an  ordinary  and  nec- 
essary expense  of  operation  and  maintenance,  and  as 
such  will  be  deductible  from  gross  income." 

Campaign  contributions  and  lobbying  expenses. — The  In- 
come Tax  law  provides  for  the  deduction  only  of  or- 
dinary and  necessary  expenses  paid  within  the  year 
in  the  maintenance  and  operation  of  its  business  and 
properties."     Sums   of  money  expended  for  lobbying 


212  INCOME    AND    FEDERAL    TAX   REPORTS 

purposes  and  contributions  for  campaign  expenses  are 
held  not  to  be  an  ordinary  and  necessary  expense  in 
the  operation  and  maintenance  of  the  business  of  a 
corporation  and  are  therefore  not  deductible. 

Donations  must  represent  consideration  of  value. — Dona- 
tions by  corporations  which  legitimately  represent  a 
consideration  for  a  benefit  flowing  directly  or  indirectly 
to  the  corporation  as  an  incident  of  its  business  are 
allowable  deductions.  This  would  include,  for  example, 
donations  to  a  hospital  upon  consideration  that  em- 
ployees of  the  corporation  are  to  have  a  ward  for  their 
use  in  case  of  accident  or  illness.  The  absence  of  con- 
sideration moving  in  some  form  to  the  corporation  will 
make  the  contribution  a  mere  gratuity,  which  would  not 
be  deductible. 

Donations  for  obtaining  good-will. — A  corporation  en- 
gaged in  agricultural  business  is  not  allowed  to  make  a 
deduction  on  account  of  donations  to  fairs,  churches, 
and  associations,  when  such  donations  are  made  for 
the  purpose  of  obtaining  and  holding  the  good-will  of 
the  farmers  who  raise  crops  for  it,  since  the  amounts 
so  expended  are  clearly  in  the  nature  of  gratuities  and 
are  not  necessary  expenses  of  operation  and  main- 
tenance. 

Salesmen's  spending  or  treating  money.  —  The  so-called 
spending  or  treating  money  actually  advanced  by  cor- 
porations to  their  traveling  salesmen  as  a  part  of  the 
selling  expense  of  the  product  of  such  corporations  is  an 
allowable  deduction  in  a  return  of  income  by  such  cor- 
poration. There  must  be  some  evidence  shown  that  all 
the  allowance  claimed  as  a  deduction  was  actually  ex- 
pended for  the  specified  purpose,  namely,  the  selling 
of  the  product  of  the  corporation  in  question. 

Donations  and  gifts. — A  glance  at  the  above  decisions 
will  show  that  the  main  purpose  is  to  make  a  sharp 
distinction  between  gratuities,  or  payments  from  which 
no  benefit   accrues   to   the  corporation,    and   expenses 


INCOME    TAX   ON    CORPORATIONS  213 

which  result  directly  or  indirectly  in  a  benefit  to  the 
corporation.  To  make  this  distinction  is,  in*  some  cases, 
rather  difficult.  A  cash  donation  to  a  church  fair  is, 
in  the  author's  opinion,  no  less  an  expense  than  an 
advertisement  in  the  program  for  such  fair.  There  are 
certain  contributions  to  local  activities  which  must  be 
made  by  a  corporation  in  order  to  keep  the  good-will 
of  the  public.  These  donations  are  a  form  of  adver- 
tising and  should  be  allowable  as  necessary  expenses 
of  the  business.  Opposed  to  these  petty  gratuities  we 
have  contributions  which  do  not  add  to  the  good-will 
of  the  corporation  and  which  are  not  necessary  to  the 
operation  of  its  business.  The  word  "necessary"  may 
be  variously  interpreted,  and  it  is  impossible  to  write 
a  definition  that  will  be  equitable  in  every  case.  The 
tendency  which  in  the  past  was  very  common  in  close 
corporations  to  charge  personal  donations  as  expenses 
of  the  corporation  will  be  lessened,  because  of  the 
amendment  in  the  law  permitting  individuals  to  deduct 
contributions  made  to  religious,  charitable  and  educa- 
tional organizations  up  to  15  per  cent  of  the  individ- 
ual's net  taxable  income. 

Ordinary  and  incidental  repairs. — Under  this  caption 
should  be  reported  all  expenditures  for  incidental  re- 
pairs which  neither  add  to  the  value  of  the  property  nor 
appreciably  prolong  its  life,  but  which  keep  it  in  an 
operating  condition. 

Expenditures  for  new  buildings,  permanent  improve- 
ments or  betterments  which  increase  the  value  of  prop- 
erty, or  for  restoring  or  replacing  property,  are  not 
deductible  under  this  or  any  other  item  of  return. 
Such  expenditures  are  chargeable  to  capital  accounts. 

Premiums  on  life  insurance. — A  corporation  is  not  per- 
mitted to  deduct  from  income  the  premium  paid  on  life 
insurance  policies  covering  the  lives  of  officers,  em- 
ployees or  those  financially  interested  in  the  trade  or 
business.     However,   the   total    amount    of   the   annual 


214        INCOME   AND    FEDERAL    TAX   REPORTS 

premiums  paid  may  be  deducted  from  the  gross  pro- 
ceeds of  any  policies  of  which  the  corporation  is  bene- 
ficiary, when  such  proceeds  are  received.1 

Depositors'  guaranty  fund. — Banking  corporations  which 
are  required  by  State  laws  to  make  contributions  to  a 
"Depositors'  Guaranty  Fund"  may  deduct  the  full 
amount  levied  against  them.  This  amount  may  be  de- 
ducted even  though  it  is  not  paid  out,  but  simply  car- 
ried on  the  books  as  a  credit  to  the  State  banking  board. 

Organization  expenses. — The  attitude  of  the  accountant 
with  regard  to  organization  expenses  of  a  corporation 
is  that  such  expenses  do  not  create  an  asset  which  has 
any  tangible  or  residual  value,  and  that  they  should  be 
charged  off  over  as  short  a  period  as  possible.  The  po- 
sition of  the  Treasury  Department  as  stated  in  T.  D. 
2499  is  that  such  expenses  are  a  capital  item  and  are 
not  deductible  in  computing  net  income  subject  to  the 
tax. 

The  text  of  this  decision,  with  the  arguments  of  the 
Government  in  support  of  its  position,  is  as  follows: 

Numerous  inquiries  have  been  made  to  this  office  with  respect  to  the 
treatment  by  corporations  in  their  returns  of  annual  net  income  of  what 
are  commonly  known  and  designated  as  "organization  expenses" — that  is, 
attorneys'  and  accountants'  fees,  together  with  fees  paid  to  the  state  au- 
thorities prior  to,  or  coincident  with,  the  securing  of  a  charter  and  the 
incorporation  of  the  company. 

In  the  absence  of  a  formal  and  definite  ruling  on  this  question,  there 
appears  to  have  been  some  conflict  in  the  holdings  and  instructions  issued 
by  this  office  in  regard  to  this  matter.  Therefore,  in  order  to  make  definite 
the  position  of  the  bureau  and  to  promote  consistency,  it  is  held  that 
"organization  expenses"  constitute  a  capital  investment,  such  expenses 
being  offset  by  the  asset  value  of  the  corporate  franchise,  an  intangible 
asset  of  a  somewhat  permanent  character  and  in  many  instances  of  sub- 
stantial value.  Such  expenses  are  very  similar  in  character  to  the  discount 
at  which  the  stock  issued  by  a  corporation  is  being  sold,  the  only  effect 
of  such  expenses  and  discounts  being  to  reduce  the  amount  of  capital 
available  for  use  and  employment  of  the  business  of  the  corporation.  The 
discount  at  which  the  stock  is  sold  is  not  a  loss  sustained  within  the 
meaning  of  the  law,  and  therefore  is  not  deductible.  Likewise,  "organiza- 
tion expenses" — that  is  to  say,  expenses  incident  to  and  connected  with 
the  incorporation  and  organization   of   the  company — are   not   "ordinary 

i  See  chapter  on  Corporation  Income,  page  200. 


INCOME    TAX   ON    CORPORATIONS  215 

and  necessary  expenses  of  maintenance  and  operation,"  which  are  the  only 
"expenses"  authorized  hy  the  Income  Tax  law  to  be  deducted  from  gross 
income. 

Hence  it  is  held  that  "organization  expenses"  do  not  constitute  an  allow- 
able deduction  from  the  gross  income  of  any  taxable  year,  nor  do  such 
expenses  constitute  a  proper  item  to  be  added  to  the  cost  of  any  physical 
property  to  be  provided  for  through  the  authorized  annual  allowance  for 
depreciation. 

The  question  naturally  arises  as  to  whether  this  de- 
cision, which  was  published  June  11,  1917,  has  any  ef- 
fect on  returns  for  1916  or  previous  years.  Many 
corporations  have  deducted  their  organization  expenses 
in  previous  returns,  under  the  prevailing  impression 
that  they  were  legitimate  deductions.  Are  such  cor- 
porations subject  to  an  additional  assessment? 

It  must  be  remembered  that  the  Treasury  Decisions 
do  not  change  the  law  itself,  but  they  do  modify  the 
interpretation  of  the  law.  The  law  cannot  be  held  as 
meaning  one  thing  for  a  certain  period  and  the  oppo- 
site for  a  latter  period.  Any  Treasury  Decision  must 
therefore  be  effective  as  of  the  date  of  the  law  itself. 

The  Income  Tax  law  provides  that  necessary  ex- 
penses of  business  may  be  deducted.  The  Treasury 
Department  in  the  above  decision  states  that  it  does 
not  consider  organization  expenses  as  necessary  ex- 
penses of  business.  Therefore  additional  assessments 
may  be  levied  against  corporations  for  any  tax  due  on 
the  amount  of  organization  expenses  which  were 
charged  as  an  expense  of  business  and  deducted  from 
gross  income. 

In  some  cases  it  will  prove  profitable  for  the  cor- 
poration to  reopen  the  matter  of  its  own  accord,  and 
pay  the  additional  tax.  The  advantage  lies  in  the  fact 
that  the  amount  of  organization  expense  would  be  con- 
sidered as  a  capital  asset,  and  might  reduce  the  amount 
of  excess  profits  tax  more  than  enough  to  offset  the 
extra  income  tax. 

Rentals. — Payments  for  the  use  of  property  are  re- 
quired to  be  divided  into  two  classes:  ordinary  rentals, 


216  INCOME    AND    FEDERAL    TAX   REPORTS 

and  payments  in  lieu  of  rent.  Payments  in  lieu  of  rent 
include  all  royalties,  interest  payments  and  any  other 
charges  which  the  corporation  is  required  to  make  for 
the  right  to  use  property  in  which  it  has  no  title,  inter- 
est or  equity. 

Additions  and  betterments  made  by  tenant. — Corpora- 
tions occupying  premises  under  a  lease  which  requires 
them  to  make  all  necessary  repairs  or  improvements, 
which  revert  to  the  owner  at  the  expiration  of  the  lease, 
are  entitled  to  charge  the  cost  of  such  repairs  and  im- 
provements to  the  expense  of  business.  The  cost  of 
those  repairs  or  improvements  that  are  somewhat  per- 
manent in  character  should  be  prorated  over  the  num- 
ber of  years  constituting  the  remaining  term  of  the 
lease. 

In  the  case  of  buildings  erected  upon  leased  ground 
the  entire  cost  of  the  building  should  not  be  deducted 
in  the  year  it  is  built.  The  cost  should  be  prorated 
over  the  life  of  the  lease,  and  the  proportionate  amount 
deducted  each  year. 

Interest  paid  as  rental. — Interest  paid  on  the  bonds  of 
another  corporation  as  a  rental  payment  for  the  use 
of  property  held  under  a  lease  may  be  deducted  by  the 
lessee  corporation  as  a  payment  in  lieu  of  rent.  But 
if  the  lessee  corporation  assumes  the  bonds  of  the  lessor 
corporation,  it  may  deduct  such  interest  only  if  it  does 
not  exceed  the  limitation  placed  on  the  amount  of  in- 
terest which  may  be  deducted.1 

Payments  in  lieu  of  rent  made  by  a  lessee  to  bond- 
holders and  stockholders  of  the  lessor  corporation,  rep- 
resenting interest  on  the  outstanding  bonds  and  divi- 
dends on  the  outstanding  stock  of  the  lessor,  are 
allowable  deductions  as  an  item  of  rental  when  paid  by 
the  lessee  for  the  use  of  the  property  of  the  lessor. 

Public  utility  earnings  payable  to  State,  territory,  etc. — 
When  a  public  utility  is  constructed,  operated  or  main- 

i  See  page  243. 


INCOME    TAX   ON    CORPORATIONS  217 

tained  under  contract  with  any  State,  territory  or  po- 
litical subdivision  and  the  public  utility  corporation 
under  the  contract  with  the  State  pays  to  it  a  certain 
portion  of  its  net  earnings,  the  amount  so  paid  may  be 
deduced  as  an  expense  of  the  business. 

LOSSES,  DEPRECIATION  AND  DEPLETION 

Losses,  depreciation  and  depletion. — The  losses  which 
may  be  deducted  are  divided  into  three  classes.  First, 
losses  actually  sustained  and  charged  off;  second,  rea- 
sonable allowances  for  the  wear  and  tear  of  property 
arising  out  of  its  use  or  employment  in  the  business 
or  trade;  and  third,  a  reasonable  allowance  for  the 
depletion  of  mines  and  oil  and  gas  wells. 

Losses  actually  sustained  and  charged  off  within  the  year. 
— Losses  to  be  deducted  must  both  actually  be  sustained 
and  be  charged  off  on  the  books  during  the  year  in 
which  the  return  is  made,  and  these  losses  should  be 
based  upon  the  difference  between  the  actual  cost  of 
the  asset  and  any  salvage  value  it  may  have,  including 
in  the  latter  value  such  amounts  as  have  been  prev- 
iously set  aside  and  deducted  from  gross  income  by  way 
of  depreciation.  For  illustration,  B  Corporation  pur- 
chased in  January,  1915,  a  machine  for  $10,000,  and 
charged  off  as  depreciation  10  per  cent  of  the  cost  each 
year  during  the  years  1915  and  1916.  In  January, 
1917,  a  fire  occurred  and  the  machine  was  entirely 
destroyed  and  had  no  value  except  for  scrap  such 
scrap  value  being  $100.  No  insurance  was  carried 
on  the  machine.  The  total  loss  was  the  difference 
between  the  cost,  $10,000,  and  the  sum  of  the  amounts 
charged  off  as  depreciation,  $2,000  plus  the  scrap 
value,  $100,  or  $7,900.  This  loss  of  $7,900  may  be  de- 
ducted. 

The  cost  of  any  property  acquired  subsequent  to 
March  1,  1913,  should  include  its  actual  cost  plus  cost 
of  improvements   made   thereto   and   any   expense    in- 


218  INCOME    AND    FEDERAL    TAX    REPORTS 

curred  incident  to  the  procurement  thereof.  The  cost 
of  property  acquired  prior  to  March  1,  1913,  would  be 
the  fair  market  price  or  value  as  of  March  1,  1913, 
plus  any  improvements  made  subsequent  to  that  date 
and  any  expense  incurred  in  the  sale  thereof. 

The  loss  must  be  the  result  of  a  closed  transaction. 
Book  entries  reflecting  a  loss  (as  distinguished  from 
entries  recording  depreciation)  are  not  of  themselves  a 
proper  ground  for  a  deduction.  This  is  more  fully  dis- 
cussed in  a  later  chapter  on  depreciation. 

Losses  incurred  in  the  sale  and  retirement  of  bonds. — 
When  a  corporation  sells  its  own  bonds  at  a  discount 
the  amount  of  the  discount  should  be  prorated  over 
the  life  of  the  bonds  and  the  proportionate  part  of 
such  discount  applicable  to  each  year  during  the  life  of 
the  bonds  should  be  deducted. 

For  example,  let  it  be  supposed  that  a  corporation 
sells  an  issue  of  $1,000,000  twenty-year  bonds  at  a  dis- 
count of  10  per  cent,  or  for  $900,000.  Each  year  the 
proportionate  part  of  that  discount,  or  $5,000,  would  be 
allowable  as  a  deduction. 

Very  often  a  corporation  is  required,  under  the  terms 
of  an  indenture  securing  the  issue  of  bonds,  to  pur- 
chase and  retire  annually  a  certain  number  of  its 
bonds.  The  corporation,  to  retire  the  annual  amount, 
may  be  compelled  to  purchase  in  the  open  market  and 
to  pay  more  than  par  for  the  bonds;  under  the  terms 
of  the  mortgage  it  may  be  compelled  to  reduce  the 
bonds  by  lot  or  otherwise  at  a  premium.  In  such  cases 
the  difference  between  the  par  value  and  the  price  at 
which  they  were  purchased  for  retirement,  is  allowed 
as  a  deduction,  provided  the  bonds  were  issued  at  par. 
When  the  bonds  were  issued  at  a  premium  and  the 
premium  was  treated  as  income  for  the  year  in  which 
issued,  the  difference  between  par  and  the  purchase 
price  may  be  deducted  as  a  loss;  but  if  the  premium 
is  being  prorated  over  the  life  of  the  bond,  the  loss  is 


INCOME    TAX   ON    CORPORATIONS  219 

the  difference  between  the  price  at  which  the  bonds  were 
issued,  less  such  part  of  the  premium  as  has  been 
taken  up  as  income,  and  the  purchasing  price.  Where 
bonds  were  originally  sold  at  less  than  par  and  the 
discount  on  the  bonds  has  been  prorated  over  the  life 
of  the  bonds  and  charged  off  annually,  the  difference 
between  the  price  at  which  the  bonds  were  issued  and 
the  redemption  price  minus  an  allowance  for  the  amount 
of  discount  that  has  already  been  charged  off,  may  be 
deducted  as  a  loss  for  the  year  in  which  the  bonds  are 
purchased  for  retirement. 

Real  estate  losses. — A  loss  on  a  real  estate  transaction 
is  the  difference  between  the  selling  price  and  the  cost 
if  the  purchase  was  made  subsequent  to  March  1,  1913, 
or  the  difference  between  the  selling  price  and  the  mar- 
ket value  as  of  March  1,  1913,  if  the  property  was 
purchased  prior  to  that  date. 

The  methods  to  be  used  in  determining  the  cost  or 
market  value  of  real  estate  are  discussed  on  page  59. 

Losses  sustained  in  stock  transactions. — The  Income  Tax 
law  does  not  place  the  same  restriction  upon  corpora- 
tions as  it  does  upon  individuals  as  to  the  nature  of 
deductible  losses. 

As  previously  explained,  individuals  are  permitted 
to  deduct  all  losses  incurred  in  trade,  but  are  permitted 
to  deduct  losses  incurred  in  transactions  not  in  trade, 
but  which  are  entered  into  for  profit,  only  to  the  ex- 
tent that  profits  from  similar  transactions  are  reported 
as  income. 

The  act  of  September  8,  1916,  as  amended,  does  not 
impose  this  restriction  upon  corporations,  but  permits 
the  deduction  of:  "All  losses  actually  sustained  and 
charged  off  within  the  year  and  not  compensated  by 
insurance  or  otherwise." 

It  therefore  follows  that  any  loss  actually  sustained 
by  a  corporation,  even  through  speculation  in  stock  or 
on  margin,  which  is  properly  reflected  in  its  books  of 


220  INCOME    AND    FEDERAL    TAX    REPORTS 

accounts,  will  constitute  a  proper  deduction  from  gross 
income  of  the  year  in  which  the  loss  is  definitely  deter- 
mined. The  charter  of  a  corporation  often  permits  of 
operations  beyond  the  primary  purposes  for  which  it 
was  organized,  and  the  Treasury  Department  has  held 
that  any  loss  actually  sustained  and  properly  deduc- 
tible, under  the  regulations  for  such  deductible  losses, 
i.e.,  actually  sustained  and  charged  off,  will  constitute 
a  proper  deduction  from  gross  income  in  the  year  in 
which  the  loss  is  so  determined. 

Bad  debts. — The  deductions  for  bad  debts  allowed  to 
a  corporation  are  subject  to  the  same  restrictions  as  are 
the  deductions  allowed  to  an  individual.1  The  debt  must 
be  definitely  ascertained  to  be  uncollectible.  It  is  not 
necessary  that  the  debtor  be  adjudged  a  bankrupt,  in 
order  that  the  debt  may  be  deducted  as  a  loss.  The 
amount  of  the  claim,  the  time  the  debt  has  overrun, 
and  the  financial  condition  of  the  debtor  may  render  it 
inadvisable  to  attempt  to  collect  the  item  by  suit. 

Inasmuch  as  the  item  of  "losses  charged  off"  is  one 
which  the  taxpayer  is  frequently  called  upon  to  sub- 
stantiate, every  corporation  should  be  prepared  to  sup- 
port this  item  of  deduction  either  by  a  notice  of  the 
debtor's  discharge  in  bankruptcy  or  by  correspondence 
showing  a  reasonable  ground  for  charging  off  the  ac- 
counts as  uncollectible.  If  at  any  subsequent  period 
the  debt  is  collected,  the  sum  so  collected  must  be  in- 
cluded as  income. 

Reserves  for  bad  debts  or  other  losses. — Reserves  cre- 
ated to  provide  for  bad  debts  which  might  prove  uncol- 
lectible in  the  future  are  not  a  proper  deduction  for  the 
purpose  of  the  income  tax.  The  same  rule  applies  to 
reserves  for  discounts  on  outstanding  accounts  receiv- 
able, reserves  for  contingencies  or  similar  anticipations 
of  losses  which  have  not  been,  and  may  never  be, 
charged  off  or  actually  sustained. 

i  See  page  122. 


INCOME    TAX   ON    CORPORATIONS  221 

But  insurance  premiums,  including  credit  insurance 
premiums,  paid  for  protection  against  the  above  losses, 
may  be  deducted. 

Depreciation. — A  reasonable  allowance  for  the  exhaus- 
tion, wear  and  tear  of  property  arising  out  of  its  use  or 
employment  in  the  business  or  trade  is  an  allowable 
deduction. 

It  is  important  to  distinguish  between  fluctuation  and 
depreciation.  The  former  is  a  change  in  the  market 
value  of  the  assets,  either  favorable  or  unfavorable, 
which  is  due  to  causes  apart  from  the  business.  These 
fluctuations,  as  we  have  already  stated,  should  not  be 
taken  into  consideration  in  determining  the  net  income 
until  the  profit  or  loss  has  been  definitely  determined 
as  the  result  of  a  closed  transaction. 

Depreciation,  on  the  other  hand,  is  a  decline  in  the 
value  of  property  as  a  result  of  wear  and  tear.  It  is 
due  to  the  possession  and  use  of  the  assets  and  is 
therefore  a  proper  deduction  from  the  income  produced 
by  the  assets. 

Repairs  and  renewals. — In  Cumberland  Telephone  and 
Telegraph  Co.  vs.  City  of  Louisville  (187  Fed.  Rep., 
637)  the  court  defined  depreciation  as  "the  loss  in  value 
of  some  destructible  property  over  and  above  current 
repairs."  The  distinction  between  repairs  and  deprecia- 
tion is  sometimes  difficult  for  the  layman  to  appreciate, 
but  to  get  a  grasp  of  the  subject,  the  distinction  must 
be  understood  thoroughly. 

An  understanding  can  perhaps  best  be  given  by  using 
an  imaginary  concrete  example.  A  company  may  have 
a  gross  income  of  $100,000  and  spend,  besides  $50,000 
for  producing,  selling  and  administrative  expenses, 
$1,000  for  repairs  of  its  property.  Its  total  money 
spent  for  operations,  therefore,  would  be  $51,000.  But 
this  does  not  represent  the  total  cost  of  earning  the 
$100,000  of  gross  income.  This  total  cost  should  cover 
loss  of  value  of  the  plant  not  included  in  the  $1,000 


222  INCOME    AND    FEDERAL    TAX    REPORTS 

actually  paid  out  for  repairs.  The  income,  therefore, 
should  be  charged  with  this  amount  of  loss,  and  the 
same  amount  credited  to  an  appropriate  reserve  ac- 
count. From  year  to  year  the  ordinary  repairs  re- 
quired to  keep  the  property  in  normal  working  condi- 
tion should  be  charged  to  income,  that  is,  deducted  in 
arriving  at  the  amount  of  taxable  net  income.  But,  be- 
sides ordinary  repairs,  there  should  also  be  deducted 
the  amount  credited  to  the  depreciation  reserve. 

Suppose,  now,  in  some  year,  it  is  decided  to  overhaul 
the  property  generally  and  to  do  more  than  is  just  nec- 
essary to  keep  the  property  in  good  efficient  operating 
condition.  This  may  cost  $5,000.  Since  $4,000  of  this 
is  spent  to  conserve  the  life  of  the  asset,  and  since 
this  is  the  very  reason  why  the  income  was  charged 
with  income  that  was  not  spent,  this  $4,000  will  not  be 
a  proper  charge  to  the  income  of  the  year  in  question. 
It  will  be  charged  to  the  reserve.  In  other  words,  the 
company  will  now  merely  be  spending  the  amounts  de- 
ducted from  income  of  the  previous  years  though  not 
spent  in  those  years.  In  short,  the  $4,000  representing 
extraordinary  work  for  maintaining  the  life  of  the 
property  could  not  be  deducted  as  an  expense  in  arriv- 
ing at  the  taxable  amount  of  net  income. 

The  distinction  between  repairs  which  do  not  prolong 
the  life  of  an  asset,  and  renewals  which  offset  the  de- 
preciation that  has  already  occurred,  is  brought  out  in 
the  following  extract  from  a  letter  from  former  Com- 
missioner of  Internal  Eevenue  Osborn  to  the  Corpora- 
tion Trust  Co.: 

"This  office  recognizes  the  fact  that  a  building  or  a  piece  of  machinery 
or  other  equipment  as  a  whole  may  deteriorate  in  value  and  usefulness  by 
reason  of  wear  and  tear,  regardless  of  the  fact  that  certain  minor  com- 
ponent parts  may  be  renewed,  restored  and  replaced.  The  depreciation 
deduction  authorized  by  the  law,  therefore,  contemplates  the  creation  of 
a  fund  that  will  renew,  restore,  or  replace  the  original  property  when  it  has 
become  worn  out  or  exhausted,  regardless  of  the  renewal  and  restoration  of 
parts  that  may  have  been  made  in  the  meantime.  Hence  it  is  held  that  in 
addition  to  the  depreciation  intended  to  cover  the  cost  of  the  property  as 


IX  CO  HE    TAX    ON    VORPO  RAT  10X8  223 

a  whole,  the  expense  of  incidental  repairs  which  do  not  add  to  the  cost  of 
the  property  but  merely  keep  it  in  an  operating  condition,  may  be  allowably 
deducted  from  gross  income  as  an  expense  of  operation  or  maintenance. 

"It  is  barely  possible  in  some  instances  that  worn  out  parts  of  a  machine 
or  similar  equipment  may  be  renewed  one  after  another  until  the  original 
machine  or  equipment  is  swallowed  up  in  the  renewed  parts  and  the  machine 
or  equipment  is  then  in  as  good  operating  condition  as  it  originally  was. 
In  this  case,  if  the  cost  of  renewal  parts  is  charged  to  operating  expense, 
no  deduction  on  account  of  depreciation  should  be  claimed  or  allowed  as 
to  such  machine  or  equipment. 

"This  would  appear  to  be  true  in  the  case  of  pipe  lines,  worn  out  pipe 
covering  and  similar  articles  of  equipment.  By  replacing  one  joint  of  pipe 
after  another,  all  may  be  replaced,  and  if  the  expense  is  deducted  as  an 
operating  expense,  any  depreciation  fund  that  may  have  been  reserved  for 
the  purpose  of  restoring  the  pipe  line  as  a  whole,  will  remain  unused. 

"So  that  in  cases  of  this  kind,  if  a  depreciation  reserve  is  set  up  to  cover 
property  that  may  be  renewed  or  restored,  part  by  part,  until  the  whole  is 
renewed,  the  cost  of  the  renewed  parts  should  be  charged  to  the  deprecia- 
tion reserve  fund  and  will  not  be  considered  incidental  expenses  within  the 
meaning  of  the  regulations  hereinbefore  referred  to." 

The  rate  of  depreciation. — Neither  the  Income  Tax  law 
nor  any  regulations  of  the  Treasury  Department  pro- 
vide for  any  definite  rates  at  which  the  allowance  for 
depreciation  should  be  calculated.  The  only  restriction 
is  that  the  allowance  deducted  should  represent  as 
nearly  as  possible  the  loss  in  value  of  the  property. 

The  basis  on  which  the  depreciation  is  to  be  calcu- 
lated depends  upon  three  factors — the  cost  of  the  asset, 
the  life  of  the  asset,  and  the  residual  value  of  the  asset. 

The  residual  value. — Most  assets,  whatever  their  life 
may  be,  have  a  scrap  or  residual  value.  No  machine  is 
absolutely  worthless,  even  if  it  has  to  be  sold  for  old 
iron.  This  residual  value  should  be  estimated  as  ac- 
curately as  possible.  The  total  amount  to  be  charged 
off  should  be  ascertained  by  deducting  the  residual 
value  from  the  original  cost. 

The  cost  of  the  asset. — Inasmuch  as  the  allowance  for 
depreciation  is  to  provide  for  the  replacement  of  the 
asset  when  it  is  worn  out,  the  total  amount  of  deprecia- 
tion to  be  deducted  would  be  limited  to  the  cost  of  the 
asset,  less  its  residual  value.    Where  the  book  value  of 


224  INCOME    AND    FEDERAL    TAX    REPORTS 

the  asset  has  been  written  up  or  increased,  the  depre- 
ciation may  be  taken  only  upon  the  original  cost  of  the 
asset,  and  not  upon  the  book  value,  inasmuch  as  profits 
caused  by  revaluation  of  assets  are  not  taxable  income; 
such  revaluation  figures  would  be  allowable  as  a  basis 
from  which  to  estimate  depreciation  only  in  case  the 
increase  in  book  value  of  the  asset  has  been  included 
as  income  and  the  tax  paid  on  such  income  at  the  time 
of  the  revaluation. 

The  life  of  the  asset. — The  final  factor  in  determining 
the  amount  of  annual  depreciation  is  the  life  of  the 
asset.  It  is  impossible  to  establish,  with  any  degree 
of  accuracy,  a  uniform  statement  of  the  life  of  various 
classes  of  assets.  The  factors  affecting  the  life  of  an 
asset  are  many,  including  the  use  to  which  it  has  been 
put,  the  care  taken  of  the  asset,  and  the  extent  to  which 
it  has  been  kept  in  repair.  The  deduction  allowed  by 
the  Income  Tax  law  does  not  include  any  provision  for 
obsolescence,  but  should  the  property  become  obsolete 
or  worthless  before  its  estimated  probable  life  has  ex- 
pired, a  deduction  representing  the  difference  between 
the  cost  of  the  property  and  the  amount  previously 
charged  off  for  depreciation  may  be  deducted  as  a  loss, 
the  amount  in  question  being  due  to  the  obsolescence  of 
the  property. 

The  loss  due  to  obsolescence  of  the  property  is  sepa- 
rate from  the  depreciation  caused  by  the  wear  and 
tear  on  the  property  as  a  result  of  its  use  in  business, 
and  is  deductible  only  when  such  obsolescence  has  actu- 
ally occurred.  It  is  not  necessary  that  the  property  be 
actually  sold  in  order  to  establish  the  fact  of  obso- 
lescence. 

A  clear  statement  of  the  factors  to  be  considered  in 
estimating  the  life  of  a  building  is  contained  in  the  de- 
cision in  Cohen  vs.  Lowe  (234  Fed.,  474).  The  opinion 
of  the  court  was  as  follows: 

"The  plaintiff  was  allowed  3  per  cent  for  depreciation  on  an  apartment 
house  owned  by  him.     The  burden  is  on  him  to  show  that  depreciation  so 


INCOME    TAX   ON    CORPORATIONS  225 

allowed  was  too  small.  This  allowance  is  for  the  wear  and  tear  suffered 
by  the  building  during  the  tax  year,  which  means  the  physical  deteriora- 
tion the  building  suffered  during  that  period.  It  does  not  take  into  ac- 
count depreciation  in  value  due  to  a  loss  in  rental  value  because  of  the 
construction  of  more  modern  buildings  with  improved  facilities,  or  due 
to  a  change  in  the  neighborhood.  It  is  to  be  based  upon  the  life  of  the 
building  in  the  sense  of  the  number  of  years  the  building  would  remain 
in  a  condition  to  be  habitable  for  the  use  for  which  it  was  constructed  and 
used,  and  which  was  in  the  present  case  for  an  apartment  housp,  and  not 
merely  the  number  of  years  it  would  stand  without  being  condemned  and 
torn  down." 

The  Treasury  Department  has  consistently  refused 
to  commit  itself  to  any  fixed  rates  of  depreciation  on 
any  class  of  property,  inasmuch  as  depreciation  on  a 
certain  class  of  assets  in  a  particular  line  of  business 
may  not  equal  the  depreciation  on  a  similar  class  of 
assets  in  a  different  line  of  business. 

The  following  table  of  the  estimated  life  of  various 
classes  of  assets  is  not  intended  to  be  authoritative,  but 
it  will  give  a  general  idea  of  the  rate  of  depreciation 
on  the  classes  of  property  listed. 

Asset  Estimated  life 

Brick  Buildings    50-60  years 

Frame  Buildings   , 30-35  years 

Brick  Buildings — Heavy  Machinery 25-35  years 

Frame  Buildings — Heavy  Machinery 20-25  years 

Machinery   8-20  years 

Furniture  and  Fixtures 5-10  years 

Wagons    10-15  years 

Automobiles  5-7  years 

Land  and  buildings. — Land  is  not  subject  to  any  de- 
preciation as  a  result  of  wear  and  tear,  although  land 
used  for  agricultural  purposes  is  subject  to  a  loss  of 
fertility  unless  this  is  prevented  by  the  use  of  fertilizers 
or  proper  rotation  of  crops,  which  loss  is  a  form  of 
depletion  and  should  be  shown  under  that  particular 
heading.  It  is  necessary,  therefore,  for  the  purpose  of 
calculating  depreciation,  to  separate  the  value  of  the 


226  INCOME    AND    FEDERAL    TAX    REPORTS 

land  from  the  value  of  the  improvements.  Unless  the 
improvements  were  made  by  the  corporation  after  it 
had  purchased  the  land,  it  would  be  difficult  to  ascer- 
tain the  cost  of  the  building  as  distinguished  from  the 
land.  Where  the  cost  of  the  building  cannot  be  ascer- 
tained, it  is  permissible  to  use  an  estimated  value  as  of 
March  1,  1913. 

Methods  of  calculating  depreciation. — Having  settled 
upon  the  factors  affecting  the  amount  of  depreciation, 
namely,  the  cost,  the  life,  and  the  residual  value  of  the 
asset,  the  next  step  is  to  calculate  the  amount  to  be 
charged  off  each  year.  There  are,  generally  speaking, 
six  distinct  methods  of  distributing  the  amount  of  the  de- 
preciation over  the  life  of  the  asset,  as  follows:  (1)  the 
fixed  percentage  method,  (2)  the  weighted  year  method, 
(3)  declining  balance  unscientific,  (4)  declining  balance 
scientific,  (5)  sinking  fund,  (6)  periodical  revaluation. 

Fixed  percentage  method.  —  The  simplest  and  most 
popular  method  is  the  "fixed  percentage."  The  differ- 
ence between  the  cost  and  residual  value  of  the  asset  is 
divided  by  the  estimated  life  of  the  asset,  and  the  result 
is  charged  off.  The  effect  is  that  an  equal  amount  of 
depreciation  is  charged  off  each  year.  The  argument 
against  this  method  is  that  as  an  asset  becomes  older 
the  cost  of  repairs  necessary  to  keep  it  in  proper  con- 
dition increases,  and  since  the  income  is  charged  with 
the  amount  of  depreciation  as  well  as  with  the  cost  of 
ordinary  repairs,  the  charges  against  income  are  heav- 
iest in  the  latter  years  of  the  life  of  the  asset. 

The  weighted  year  method. — The  weighted  year  method 
answers  this  objection  by  decreasing  the  amount  of  de- 
preciation each  year,  thus  equalizing  the  total  charges 
of  depreciation  and  repairs.  The  amount  of  deprecia- 
tion may  be  determined  for  any  year  by  multiplying 
the  total  depreciation  by  a  fraction  having  the  number 
of  years  the  asset  will  still  last  as  a  numerator,  and 
the  sum  of  the  total  years  of  its  life  as  a  denomina- 


INCOME    TAX   ON    CORPORATIONS  227 

tor.1  To  illustrate,  an  asset  costs  $1,500,  and  has  a 
life  of  10  years  and  a  residual  value  of  $400;  the  total 
depreciation  is  therefore  $1,100.  Applying  the  weighted 
year  method  of  calculating  the  depreciation  for  the 
first  year,  simply  multiply  the  total  depreciation,  $1,000, 

by  the  fraction  referred  to,  i.e.,  ~  X  $1,100  -  $200.   The 

oo 
9 
depreciation   the    second   year   is  —  X  $1,100,    or   $180. 

g 

The  depreciation  the  third  year  is  —  X  $1,100,  or  $160. 

55 

The  depreciation  the  tenth  year  is  —  X  $1,100,  or  $20. 

55 

The  declining  balance  unscientific. — The  declining  bal- 
ance unscientific  method  is,  as  its  name  implies  "unsci- 
entific." Instead  of  deducting  the  same  amount  each 
year,  as  under  the  fixed  percentage  method,  an  arbi- 
trary percentage  is  calculated  on  the  declining  value  of 
the  asset,  as  follows: 

Cost  of  asset,  $1,000;  life,  5  years;  residual  value,  $100. 

Cost $1,000.00 

Depreciation,  20  per  cent 200.00 

Value,  end  of  first  year $800.00 

Depreciation,  20  per  cent 160.00 

Value,  end  of  second  year $640.00 

Depreciation,  20  per  cent 128.00 

Value,  end  of  third  year $512.00 

Depreciation,  20  per  cent 102.40 

Value,  end  of  fourth  year $409.60 

Depreciation,  20  per  cent 81.92 

Value,  end  of  fifth  year $327.68 

Residual  value 100.00 

Depreciation,  not  written  off $227.68 

i  For  example,  if  the  life  were  10  years,  this  sum  would  be  the  sum  of 
1+2+3+4+5+6-1-7+8-1-9-1-10=55.    The  formula  for  the  sum  of  an  arith- 
metic progression  is  N   (A  plus  Z)   where  N  is  the  number  of  terms  and 
_ 

A  is  the  first  term  and  Z  is  the  last  term.    The  sum  of  the  numbers  from 

10    (1   plus  10)  110 

1  to  10  would  be    ~ =  ~~o~  =  55- 


228  INCOME   AND    FEDERAL    TAX   REPORTS 

It  will  be  seen  that  this  method  does  not  provide 
enough  depreciation,  and  that  an  extra  charge  is  neces- 
sary at  the  end  of  the  last  year.  This  method,  it  will 
be  noticed,  does  not  entail  an  estimate  of  the  probable 
life  of  the  asset. 

The  declining  balance  scientific. — The  declining  balance 
scientific  method  is  similar  to  the  unscientific,  with  the 
exception  that  the  percentage  is  accurately  calculated 
so  as  to  take  up  the  full  amount  of  the  depreciation.1 

The  sinking  fund  method. — The  sinking  fund  method 
requires  a  fixed  sum  to  be  set  aside  annually  which, 
with  interest,  will  at  the  end  of  the  life  of  the  asset 
equal  the  total  amount  of  depreciation.  This  method 
involves  rather  confusing  interest  adjustments  and  is 
seldom  used. 

Periodical  revaluation. — The  periodical  revaluation  of 
assets  cannot  be  used  to  determine  the  amount  of  de- 
preciation deductible  for  the  income  tax,  as  these  val- 
uations take  into  consideration  changes  in  value  due  to 
causes  other  than  wear  and  tear. 

Amount  of  depreciation  under  each  method.  —  The 
amounts  of  depreciation  for  each  year  under  the  various 
methods  which  have  been  described  are  shown  by  the 
chart  on  page  229. 

Since  the  amount  deducted  for  depreciation  must  be 
supported  by  a  statement  of  the  nature  of  the  asset,  its 
cost,  its  estimated  life  after  purchase,  and  the  amounts 
previously  deducted  for  depreciation,  it  would  be  ad- 
visable, unless  the  fixed  percentage  method  has  been 
used,  to  attach  a  statement  to  the  return,  showing  the 
method  employed. 

i  The  formula  for  finding  the  required  percentage  to  reduce  original 
value  "V"  to  salvage  value  S  through  a  period  of  years,  "X"  being  the  rate 
to  be  calculated,  is 


X-l-V       S_ 
V 


INCOME    TAX   ON    CORPORATIONS 


229 


COST,  $1,000;    ESTIMATED  LIFE,  FIVE  YEARS;    ESTIMATED 
RESIDUAL  VALUE,  $100 

Amount  to  be  Deducted  Annually 


Years 

Fixed 
Per- 
centage 

Fractional 

method 

Weighted 

Years 

Declining 
Balance 

Unscien- 
tific 20% 

Declining 

Balance 

Scientific 

.36905 

Sinking 
Fund 

Reval- 
uation 

1  year 

2  years 

3  years 

4  years 

5  years 

$180.00 
1S0.00 
180.00 
180.00 
180.00 

$300.00 

240.00 

180.00 

120.00 

60.00 

$200.00 
160.00 
128.00 
102.40 
309.60 

$369.05 

232.85 

146.90 

92.70 

58.50 

$162.87 
162.87 
162.87 
162.87 
162.87 

$250.00 
225.00 
125.00 
175.00 
125.00 

Depreciation.  . 
Interest  5% 

$900.00 

$900.00 

$900.00 

$900.00 

$814.35 

85.65 

100.00 

$900.00 

Residue 

100.00 

100.00 

100.00 

100.00 

100.00 

Total 

$1,000.00 

$1,000.00 

$1,000.00 

$1,000.00 

$1,000.00 

$1,000.00 

Value  of  Asset  at  End  of  Each  Year 


Years 


Fractional 

Declining 

Declining 

Fixed 

Method 

Balance 

Balance 

Sinking 

Per- 

Weighted 

Unscien- 

Scien- 

Fund 

centage 

Years 

tific 

tific 

Method 

$820.00 

$700.00 

$800.00 

$630.95 

$837.13 

540.00 

460.00 

640.00 

398.10 

666.12 

360.00 

280.00 

512.00 

251.20 

486.56 

180.00 

160.00 

409.60 

158.50 

298.02 

100.00 

100.00 

100.00 

100.00 

100.00 

Reval- 
uation 
Arbitrary 


1  year. 

2  years 

3  years 

4  years 

5  years 


$750.00 
525.00 
400.00 
225.00 
100.00 


Assets  on  which  depreciation  may  be  deducted. — De- 
preciation may  be  deducted  only  on  such  assets  as  are 
subject  to  wear  and  tear  as  a  result  of  their  use  in 
connection  with  the  business  of  the  corporation,  but  no 
depreciation  may  be  deducted  on  assets  which  are  the 
stock  in  trade  of  the  corporation.  Under  certain  condi- 
tions, discussed  in  detail  under  Inventories  (page  182, 
ante),  this  depreciation  in  value  may  be  taken  into  con- 
sideration in  valuing  the  asset  for  inventory  purposes. 


230  INCOME   AND    FEDERAL    TAX    REPORTS 

Where  this  is  not  allowed  the  shrinkage  in  value  will 
be  reflected  in  the  sales  when  the  assets  are  disposed  of. 

Depreciation  of  patents. — While  a  patent  is  not  subject 
to  any  loss  as  a  result  of  wear  and  tear,  its  life  is  lim- 
ited to  a  maximum  of  seventeen  years.  The  cost  of  the 
patent  may  be  prorated  over  the  number  of  years  it 
has  to  run  and  the  proportionate  part  deducted  each 
year  as  depreciation.  Where  the  patent  has  been  se- 
cured from  the  Government  by  a  corporation  itself,  its 
cost  would  be  represented  by  the  various  Government 
fees,  cost  of  drawings,  experimental  models,  attorneys' 
fees,  etc.  These  items  should  not  be  deducted  as  an 
expense  in  the  year  incurred,  but  should  be  capitalized 
and  spread  over  the  life  of  the  patent.  If  the  value  of 
the  patent  were  written  up  or  appreciated  on  the  books 
of  the  owner,  depreciation  could  still  be  deducted  only 
on  its  original  cost,  unless  the  appreciation  in  the  value 
of  the  patent  had  been  previously  reported  as  income 
for  income  tax  purposes,  in  which  case  depreciation 
could  be  deducted  on  the  appreciated  value.  Where  the 
patent  has  been  purchased  by  the  corporation  for  a 
cash  consideration,  the  amount  paid  would  represent  the 
cost.  Where  the  corporation  has  purchased  a  patent 
and  paid  for  it  in  stocks  or  other  securities,  the  actual 
value  of  such  securities  at  the  time  of  the  purchase  will 
be  the  cost  of  the  patent  to  the  corporation.  Should 
the  value  of  the  patent  disappear  through  obsolescence 
or  any  other  cause,  before  the  patent  expires,  the  bal- 
ance of  the  cost  of  the  patent  may  be  deducted  as  a 
loss. 

Depreciation  of  other  intangible  assets. — A  reasonable 
amount  of  depreciation  may  also  be  deducted  on  other 
intangible  assets,  with  the  exception  of  good-will.  Copy- 
rights, for  example,  are  treated  exactly  the  same  as 
patents.  Amounts  paid  in  consideration  of  a  contract 
having  several  years  to  run  may  also  be  charged  off 
over  the  life  of  the  contract. 


INCOME    TAX    ON    CORPORATIONS  231 

Depreciation  of  good-will. — Good-will,  for  income  tax 
purposes,  is  subject  neither  to  appreciation  nor  to  de- 
preciation, regardless  of  whether  or  not  it  has  been 
paid  for  by  the  corporation.  Any  amount  charged  off 
as  a  decrease  in  the  value  of  good-will  is  not  deduc- 
tible. On  the  other  hand,  a  surplus  created  by  "writing- 
up"  the  value  of  good-will  is  not  considered  taxable 
income. 

Necessity  for  book  entry  of  depreciation. — The  1913  In- 
come Tax  law  permitted  the  deduction  of  "a  reason- 
able allowance  for  depreciation  by  use,  wear  and  tear 
of  property."  It  did  not  require  that  the  amount 
claimed  must  be  written  off  on  the  books  in  order  to 
permit  its  deduction.  The  Treasury  Department,  how- 
ever, held  that  the  depreciation  must  be  charged  off  on 
the  books  of  the  corporation  to  permit  its  deduction.  On 
the  strength  of  this  ruling  many  income  tax  inspectors 
refused  to  allow  the  deduction  of  depreciation,  solely 
on  the  ground  that  the  amount  had  not  been  charged 
off  on  the  books  of  the  corporation.  To  remedy  this 
condition  the  Commissioner  of  Internal  Revenue  issued 
a  letter  of  instructions  to  collectors,  from  which  the 
following  is  an  extract: 

"It  is  not  the  desire  of  this  office  to  deny,  upon  purely  technical  grounds, 
a  deduction  which  the  law  authorized  and  which  conforms,  or  may  be 
made  to  conform,  to  the  regulations.  Revenue  agents  and  examining  offi- 
cers, in  the  examination  of  the  books  of  a  corporation,  will,  therefore, 
determine  whether  or  not  the  deduction  claimed  in  its  return  is  a  fair  and 
reasonable  measure  of  the  loss  sustained  during  the  year,  and,  if  they  find 
that  the  amount  claimed  in  a  return  is  such  fair  and  reasonable  measure 
of  the  loss,  and  that  it  was  not  written  off  on  the  books  of  the  corporation, 
they  will  permit  the  corporation  to  reopen  its  books  if  it  so  desires,  and 
make  such  entries  as  will  constitute  the  amount  sought  to  be  deducted, 
a  liability  against  the  assets  of  the  company,  and  a  charge  against  the 
income  of  the  year  for  which  the  return  is  made.  Sufficient  time  to  make 
such  correcting  entries  should  be  given  to  the  corporation  before  the  re- 
port of  the  examination  is  made  to  this  office,  and  any  recommendation  as 
to  additional  taxes  should  be  made  accordingly. 

"If  a  corporation  refuses  or  neglects  to  reopen  its  books  and  write  off 
the  depreciation  claimed  in  the  return,  or  a  reasonable  amount  measuring 
the  loss  sustained  on  this  account,  the  amount  claimed  in  the  return 
will  be  disallowed." 


232  INCOME    AND    FEDERAL    TAX    REPORTS 

Under  the  present  Income  Tax  law,  which  affects  re- 
turns for  1916  and  1917,  the  depreciation  must  be  writ- 
ten off  on  the  books  of  the  corporation,  as  the  wording 
of  the  law  is  "losses  charged  off  within  the  year — in- 
cluding a  reasonable  allowance  for  the  exhaustion,  wear 
and  tear  of  property,  arising  out  of  its  use  or  employ- 
ment in  the  business  or  trade." 

Investment  of  depreciation  reserve  funds. — The  original 
regulations  of  the  Income  Tax  law  provided  that: 

"Depreciation  set  up  upon  the  books  and  deducted  from  gross  income 
can  not  be  used  for  any  purpose  other  than  making  good  the  loss  sus- 
tained by  reason  of  the  wear  and  tear,  exhaustion  or  obsolescence  of  the 
property  with  respect  to  which  it  was  claimed.  If  it  develops  that  an 
amount  has  been  reserved  or  deducted  in  excess  of  depreciation,  the  excess 
shall  be  restored  to  income  and  so  accounted  for. 

"If  any  portion  of  the  depreciation  set  up  is  diverted  to  any  purpose 
other  than  making  good  the  loss  sustained  by  depreciation,  the  income 
account  for  the  year  in  which  such  diversion  takes  place  must  be  cor- 
respondingly increased." 

The  effect  of  this  ruling  was  to  give  taxpayers  the 
impression  that  the  law  required  that  the  amount  de- 
ducted for  depreciation  be  set  aside  in  a  separate  fund, 
and  that  the  fund  be  kept  intact  or  used  only  to  make 
good  losses  caused  by  depreciation.  This  interpreta- 
tion is  contrary  to  business  practice,  which  does  not 
consider  it  necessary  that  the  amount  charged  against 
income  be  set  aside  in  a  fund.  This  misconception  as 
to  the  intention  of  Congress  was  so  prevalent  among 
Internal  Eevenue  officers,  that  it  was  found  necessary 
to  issue  a  decision,  which  is  herewith  quoted  in  full: 

The  second  paragraph  under  Sec.  12  of  Title  I  of  the  Act  of  September 
8,  1916,  authorizes  corporations,  joint  stock  companies,  etc.,  in  making 
their  returns  of  annual  net  income,  to  deduct  from  gross  income: 

All  losses  actually  sustained  and  charged  off  within  the  year  ...  in- 
cluding a  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of 
property,  arising  out  of  its  use  or  employment  in  the  business  or  trade 
and  in  the  case  of  oil  and  gas  wells  and  mines,  a  reasonable  allowance 
for  depletion  of  natural  deposits. 

The  essential  requirements  of  this  provision  are  that  the  amounts  de- 
ductible on  account  of  depreciation  and  depletion  shall  be  charged  off  and 
shall  be  reasonable  allowances — that  is,  an  amount  sufficient  to  make  good 


INCOME    TAX   ON    CORPORATIONS  233 

the  loss  due  to  these  causes.  The  phrase  "charged  off"  contemplates  that 
the  "reasonable  allowance"  deducted  from  gross  income  on  account  of 
depreciation  and  depletion,  shall  be  credited  to  appropriate  reserve  accounts 
and  carried  as  a  liability  against  the  assets,  to  the  end  that  when  the 
total  of  these  credits  equals  the  capital  investment  account,  no  further 
deductions  on  these  accounts  will  be  allowed.  While  the  presumption  is 
that  amounts  credited  to  these  accounts  will  be  used  to  make  good  the 
loss  sustained,  either  through  a  renewal  or  replacement  of  the  property 
or  a  return  of  capital,  there  is  no  requirement  of  law  that  the  funds  repre- 
sented by  these  reserve  liabilities  shall  be  held  intact  or  remain  idle  against 
the  day  when  they  may  be  used  in  making  good  the  depreciation  of  the 
property  with  respect  to  which  the  deduction  is  claimed,  or  in  restoring 
the  capital  invested  in  the  depleted  assets. 

The  conversion  of  the  depreciation  reserve  into  tangible  assets  will  not 
constitute  such  a  diversion  as  would  deny  the  corporation  the  right  of 
deduction,  provided  in  all  cases,  that  the  deduction  claimed  in  the  return 
is  a  reasonable  allowance,  that  is,  a  fair  measure  of  the  loss  due  to  "ex- 
haustion, wear  and  tear  of  property  growing  out  of  its  use,"  and  is  charged 
off  or  so  entered  upon  the  books  as  to  constitute  a  liability  against  the 
assets  with  respect  to  which  the  depreciation  deduction  is  claimed. 

To  the  extent  that  Articles  130,  132  and  133  of  Regulations  No.  33  are 
in  conflict  with  the  foregoing  they  are  hereby  rescinded,  and  this  decision 
is  made  applicable  to  the  adjustment  of  return  of  annual  net  income  made 
pursuant  to  the  requirements  of  Section  38,  Act  of  August  5,  1909,  Section 
2  of  the  Act  of  October  3,  1913,  and  the  present  Income  Tax  law,  except 
that  as  to  returns  made  under  the  first  two  Acts,  the  writing  off  of  de- 
preciation will  not  be  insisted  upon.     (T.  D.  2481) 

DEPLETION 

Distinction  between  depletion  and  depreciation.  —  De- 
preciation, as  used  by  the  Treasury  Department,  is  lim- 
ited to  mean  the  lowering  of  value  due  solely  to  wear 
and  tear. 

Depletion  is  the  decrease  or  lowering  of  the  supply 
of  a  natural  deposit,  referred  to  as  "Exhaustion,"  in 
the  text  of  the  law. 

Depletion  of  mines. — The  amount  which  may  be  de- 
ducted as  an  allowance  for  the  depletion  of  mines  de- 
pends upon  two  factors :  the  fair  or  market  value  of  the 
natural  deposit  as  of  March  1,  1913,  and  the  number 
of  units  in  the  deposit. 

The  fair  market  value  as  of  March  1,  1913. — Section  12, 
subdivision  (e),  of  the  Law  of  1916,  authorizes  the  de- 


234  INCOME    AND    FEDERAL    TAX    REPORTS 

duction  of  "a  reasonable  allowance  for  exhaustion,  wear 
and  tear  of  property  and  ...  in  the  case  of  mines,  a 
reasonable  allowance  for  depletion  thereof,  not  to  ex- 
ceed the  market  value  in  the  mine  of  the  product 
thereof,  which  has  been  mined  and  sold  during  the 
period  for  which  the  return  and  computation  are  made 
.  .  .  provided  that  when  the  allowance  authorized  shall 
equal  the  capital  originally  invested,  or  in  case  of  pur- 
chase made  prior  to  March  first,  nineteen  hundred  and 
thirteen,  the  fair  market  value  as  of  that  date,  no  fur- 
ther allowance  shall  be  made." 

In  the  case  of  property  purchased  prior  to  March  1, 
1913,  the  fair  market  value  as  of  that  date  should  be 
the  value  on  March  1,  1913,  of  the  entire  deposits  of 
minerals  contained  in  the  property  owned,  exclusive  of 
the  improvements  and  development  work.  It  should  be 
the  price  at  which  the  natural  deposits  or  mineral 
property  as  an  entirety  in  its  condition  at  that  time 
could  have  been  disposed  of  for  cash  or  its  equivalent. 

The  detailed  method  of  arriving  at  the  fair  market 
value  of  the  mineral  deposits  as  of  March  1,  1913,  will 
vary  with  each  corporation,  the  estimate  in  all  cases 
being  subject  to  the  approval  of  the  Commissioner  of 
Internal  Eevenue. 

When  actual  cost  of  the  property  may  be  used. — The 
actual  cost  of  the  property  may  be  used  as  the  basis 
for  computing  the  amount  of  depletion  (1)  where  the 
property  was  acquired  subsequent  to  March  1,  1913,  and 
(2)  where  the  fair  market  value  as  of  March  1,  1913, 
cannot  be  ascertained.  In  this  case  allowance  should 
be  made  for  the  mineral  which  has  been  removed  prior 
to  that  date. 

Determination  of  the  number  of  units  contained  in  the 
property. — Having  determined  either  the  cost,  or  the 
fair  market  value  as  of  March  1,  1913,  an  estimate  of 
the  number  of  units  (tons,  pounds,  etc.)  should  be 
made.    The  value  of  the  property  divided  by  the  esti- 


INCOME    TAX   ON    CORPORATIONS  235 

mated  number  of  units  in  the  mine  will  determine  the 
per  unit  value,  which  multiplied  by  the  number  of  units 
mined  during  the  year  will  give  the  amount  to  be  de- 
ducted against  the  gross  income  of  that  year. 

No  instructions  are  given  in  any  Treasury  decision 
for  determining  the  number  of  units  in  a  mine.  There 
is  no  doubt  that  an  estimate  submitted  by  a  competent 
mining  engineer  would  be  an  acceptable  basis. 

Calculating  the  amount  of  depletion  to  be  deducted. — 
The  question  has  been  raised,  as  a  result  of  rulings  of 
the  Treasury  Department,  as  to  whether  the  amount  of 
annual  depletion  should  be  based  on  the  number  of 
units  mined  or  upon  the  number  of  units  sold. 

The  author  believes  that  the  calculation  should  be 
made  on  the  basis  of  the  number  of  tons  mined,  wher- 
ever records  are  kept  so  as  to  furnish  this  information, 
because  the  depletion  occurs  when  the  mineral  is  mined 
and  not  when  it  is  sold.  Mineral  mined  and  not  sold 
results  in  a  depletion  of  the  mine,  and  in  an  increase  of 
the  minerals  on  hand. 

Bookkeeping  requirements. — Every  individual  or  cor- 
poration claiming  and  making  a  deduction  for  depletion 
is  required  to  keep  an  accurate  ledger  account,  to  which 
should  be  charged  the  estimated  fair  value  as  of  March 
1,  1913,  or  the  cost,  if  the  property  was  acquired  sub- 
sequent to  that  date,  of  the  mineral  deposits.  The 
amount  deducted  each  year  for  depletion  should  be 
credited  against  this  account  and  when  the  credits  to 
the  account  equal  the  debit  no  further  allowance  for 
depletion  of  the  property  will  be  allowed. 

The  fair  market  value  as  of  March  1,  1913,  or  the 
cost,  once  determined,  will  be  used  as  the  basis  for 
determining  the  depletion  allowance.  There  can  be  no 
revaluation  for  the  purpose  of  the  depletion  deduction, 
if  it  is  found  that  the  estimated  quantity  of  mineral 
deposit  was  understated  at  the  time  the  value  was  fixed 
or  at  the  time  the  property  was  acquired.     In  other 


236  INCOME    AND    FEDERAL    TAX    REPORTS 

words,  the  "per  unit"  depletion,  once  estimated,  must 
be  used  in  determining  the  amount  of  depletion  as  long 
as  the  property  is  under  the  same  ownership.  To  illus- 
trate :  A  mine  cost  $250,000  and  is  estimated  to  contain 
1,000,000  tons  of  coal.  This  would  permit  a  $0.25  per 
ton  charge  for  depletion.  After  a  number  of  years  of 
operation  it  is  discovered  that  the  mine  contained  only 
900,000  tons.  The  total  amount  of  depletion  deducted 
after  mining  the  900,000  tons  would  be  $225,000.  The 
balance  of  $25,000  should  be  deducted  not  as  depletion 
but  as  a  loss,  because  of  the  original  error  in  estimat- 
ing the  number  of  units  in  the  deposit. 

Lessees  may  not  deduct  depletion.  —  The  rules  stated 
above  apply  only  to  the  owners  in  fee  of  mines  and 
mining  property.  Individuals  or  corporations  operat- 
ing a  mine  under  lease  or  on  a  royalty  basis  are  not 
entitled  to  any  deduction  for  depletion.  If,  however, 
the  lessee,  in  addition  to  royalties,  paid  or  pays  a  stipu- 
lated sum  for  the  right  to  explore,  develop  and  operate 
a  mine,  the  amount  so  paid  may  be  ratably  distributed 
over  the  life  of  the  lease,  or  over  the  probable  life  of 
the  mine  under  the  ordinary  operating  conditions,  and 
the  lessee  may  deduct  annually  as  rental  payment  an 
aliquot  part  of  the  amount  of  the  stipulated  sum  so 
paid. 

Statement  to  be  attached  to  return. — There  should  be 
attached  to  the  return  a  statement  showing: 

(1)  Whether  the  operator  is  a  fee  owner  or  lessee; 

(2)  In  the  case  of  a  fee  owner, 

a.  The  fair  market  value  of  the  mineral  depos- 
its as  of  March  1,  1913,  if  the  property  was  ac- 
quired prior  to  that  date;  or 

b.  The  cost  of  the  mineral  deposit  if  acquired 
subsequent  to  that  date; 

(3)  The  method  by  which  the  value  as  of  March  1, 
1913,  was  determined  in  case  the  property  was  acquired 
prior  to  that  date: 


INCOME    TAX   ON    CORPORATIONS  237 

(4)  The  estimated  quantity  in  units  in  the  mine  as 
of  March  1,  1913,  or  at  the  date  of  purchase  if  acquired 
subsequent  to  that  date; 

(5)  The  number  of  units  removed  and  sold  during 
the  year  for  which  the  return  is  made;  and 

(6)  Any  other  data  which  would  be  helpful  in  deter- 
mining the  reasonableness  of  the  depletion  deduction 
claimed  in  the  return. 

In  the  case  of  a  lessee,  the  statement  should  show: 

a.  The  amount  of  the  bonus  or  other  payment  made 
for  the  right  to  operate  the  mine; 

b.  The  period  covered  by  the  lease. 

Depletion  of  oil  and  gas  wells. — A  depletion  allowance 
is  deductible  by  owners  of  oil  or  gas  wells,  this  allow- 
ance being  designed  to  extinguish  the  capital  invested 
at  the  time  when  the  production  of  the  well  ceases. 
The  depletion  deduction  allowed  annually  is  such  a  per- 
centage of  the  unextinguished  capital  as  the  reduction 
in  flow  or  production  of  one  year  is  a  percentage  of  the 
flow  or  production  of  the  previous  year. 

The  invested  capital,  originally,  is  taken  to  be  the 
fair  market  value  of  the  gas  or  oil  properties  as  of 
March  1,  1913,  or  the  cost,  if  acquired  subsequently, 
the  figures  being  subject  to  the  approval  of  the  Com- 
missioner of  Internal  Eevenue.  This  valuation  will  be 
taken  as  the  basis  for  determining  the  depletion  deduc- 
tion for  all  subsequent  years  while  the  property  con- 
tinues under  the  same  ownership,  and  no  revaluation 
will  be  permitted.  When  the  depletion  allowances 
amount  eventually  to  the  sum  set  up  as  the  fair  value, 
no  further  deduction  for  depletion  with  respect  to  the 
property  and  the  capital  so  invested  in  it  will  be 
allowed. 

Determining  the  reduction  in  flow. — The  Income  Tax 
law  permits  the  deduction  of  "in  the  case  of  oil  and 
gas  wells,  a  reasonable  allowance  for  actual  reduction 
in  flow  and  production,  to  be  ascertained  not  by  the 


238  INCOME   AND    FEDERAL    TAX   REPORTS 

flush  flow  but  by  the  settled  production  or  regular 
flow." 

Depletion — how  determined. — The  flow  or  production  of 
a  well  as  of  March  1,  1913,  or  at  the  time  of  purchase, 
if  acquired  subsequent  to  that  date,  or  as  of  the  time 
when  it  has  reached  its  stage  of  settled  production  or 
regular  flow,  if  brought  in  as  a  new  well  subsequent  to 
March  1,  1913,  is  taken  as  the  basis  upon  which  the 
percentage  of  decline  is  computed  for  the  ensuing  year. 

If  the  total  yearly  yield  of  the  well  is  not  recorded, 
in  order  that  the  percentage  of  decline  may  be  deter- 
mined tests  may  be  made  of  the  production  or  flow  at 
the  same  certain  period  of  each  year,  as  a  basis  for 
comparison. 

In  the  case  of  a  gas  well,  two  methods  of  testing  its 
rate  of  yield  are  accepted  by  the  Department:  (1)  the 
volume  of  outflowing  gas  may  be  measured,  or  (2)  the 
"rock  pressure"  may  be  ascertained  by  the  use  of  a 
pressure  gauge.  The  first  method  is  the  more  accurate, 
but  is  sometimes  objectionable  because  of  the  waste  of 
gas  during  the  process  of  measurement. 

In  the  case  of  an  oil  well,  the  question  of  measuring 
the  flow  is  simple,  and  if  the  basis  is  the  natural  flow, 
the  computation  of  depletion  is  also  simple. 

If,  however,  the  well  has  ceased  to  flow  naturally 
and  must  be  pumped,  if  oil  is  to  be  produced,  the  sit- 
uation is  so  complicated  that  there  seems  to  be  no  solu- 
tion of  the  problem.  Of  course,  the  rate  of  decline  in 
yield  of  the  well  could  be  ascertained.  The  actual  de- 
termining element  in  ascertaining  the  possible  produc- 
tion would  be,  in  either  case,  the  pressure  (though  in 
the  case  of  the  flowing  well  it  would  not  be  necessary 
to  go  beyond  the  measurement  of  the  oil  actually 
yielded  by  the  natural  flow),  and  when  the  pressure 
had  declined  so  that  there  was  not  sufficient  to  force 
the  oil  to  the  elevation  of  the  surface  of  the  ground, 
the  pressure  would  still  be  measureable  at  a  sufficient 


INCOME    TAX   ON    CORPORATIONS  239 

depth  below  the  surface,  and  the  decline  could  be  esti- 
mated. The  difficulty,  however,  lies  in  the  fact  that  in 
such  a  case  a  number  of  new  factors  enter  into  the 
problem.  If  the  well  would  yield  a  profitable  amount 
of  oil,  if  pumped,  the  owner  might  claim  that  the  price 
of  oil  did  not  justify  him  in  going  to  the  expense  of 
installing  and  operating  the  necessary  machinery.  If 
this  were  the  case,  it  would  seem  that  if  there  were 
still  a  part  of  the  invested  capital  unextinguished,  the 
well  might  be  abandoned,  and  the  difference  between 
its  original  fair  value  and  the  sum  of  the  depletion 
allowances  which  had  been  taken  from  it  might  be  de- 
ducted in  the  tax  report,  not  as  allowance  for  depletion, 
but  as  a  loss.  In  such  a  case,  if  the  well  had  any  mar- 
ket value,  this  value  would  be  deducted  from  the 
amount  charged  off  as  a  loss. 

In  the  case  of  a  well  that  was  in  the  first  place  not  a 
flowing  well  but  a  pumper,  the  depletion  deductions 
could  be  ascertained,  as  in  the  case  of  a  flowing  well, 
by  some  means  that  would  indicate  the  decline  in  pres- 
sure; but  if,  for  instance,  the  pump  took  the  oil  from 
a  point  in  the  well  100  feet  below  the  surface  of  the 
ground,  as  the  pressure  diminished  the  oil  level  in  the 
well  would  subside  without  causing  any  decrease  in 
yield  (but  only  an  increase  in  power  required  to  oper- 
ate the  pump)  until  the  level  reached  the  pump,  when 
the  yield  would  cease  abruptly  and  completely,  neces- 
sitating either  an  abandonment  of  the  well  or  the  in- 
stalling of  a  pump  which  would  reach  a  greater  depth. 
In  this  case,  there  might  be  no  depletion,  figured  on  a 
production  basis,  for  several  years,  and  then  in  one 
year  there  would  be  a  100  per  cent  depletion. 

It  would  seem  that  there  is  need  of  definite  rulings 
by  the  Department,  covering  such  possibilities  as  these. 

Depletion  of  oil  field. — The  Treasury  Department  has 
held  that: 


240  INCOME   AND    FEDERAL    TAX   REPORTS 

In  the  case  of  a  field  or  territory  in  course  of  development  or  in  which 
new  wells  are  being  drilled,  if  the  depletion  deduction  is  to  be  availed  of 
in  the  returns  of  annual  net  income,  each  individual  well  or  possibly  each 
group  of  wells  in  operation  at  the  beginning  of,  or  brought  in  during  the 
year,  if  the  flow  and  production  of  the  group  of  wells  is  so  assembled  as 
to  be  tested,  must  be  tested  at  the  end  of  the  year  in  order  that  the  de- 
cline in  the  flow  and  production  may  be  determined. 

New  wells  or  new  groups  of  wells  brought  in  during  the  year  may  be 
tested  as  soon  as  they  have  reached  the  stage  of  settled  production  or  regu- 
lar flow,  and  then  again  at  the  end  of  the  year.  The  decline  in  flow  and 
production,  if  any,  as  indicated  by  these  tests,  will  be  reduced  to  a  per- 
centage basis  and  a  like  percentage  of  the  capital  invested  in  the  oil  or  gas 
property  (exclusive  of  machinery,  equipment,  etc.)  will  constitute  an 
allowable  deduction  from  the  gross  income  of  the  year  on  account  of  de- 
pletion. Thus,  if  the  decline  in  the  flow  and  production  during  the  year 
of,  say,  ten  wells,  costing  $100,000  has  been  5  per  cent  as  compared  with 
the  production  and  flow  as  indicated  by  a  test  made  at  the  beginning  of 
the  period,  then  5  per  cent  of  $100,000  or  $5,000  will,  for  the  year  for 
which  the  computation  is  made,  constitute  an  allowable  depletion  deduc- 
tion in  favor  of  the  individual  or  corporation  owning  and  operating  the 
property. 

If  the  wells  are  not  so  situated  that  their  flow  and  production  may  be 
assembled  in  order  to  test  and  ascertain  the  reduction  in  the  output  as  a 
basis  for  computing  depletion,  it  will  be  necessary  for  the  corporation  or 
individual  owning  the  property  and  claiming  a  depletion  deduction,  to 
take  an  accurate  gauge  of  the  production  and  flow  of  each  well  at  a  certain 
same  period  of  each  year,  and  by  comparing  this  gauge  with  that  of  the 
previous  year,  determine  the  percentage  by  which  the  production  and  flow 
has  been  reduced.  This  having  been  done  as  to  all  of  the  wells  in  opera- 
tion, an  average  percentage  rate  of  reduction  in  flow  and  production  will 
be  ascertained,  and  this  rate  will  be  applied  to  the  capital  invested,  that  is, 
the  value  of  the  oil  or  gas  property  as  of  March  1,  1913,  or  the  cost  of  the 
same,  if  acquired  subsequent  to  that  date,  for  the  purpose  of  determining 
the  amount  which  may  be  allowably  deducted  from  gross  income  by  such 
owning  individual  or  corporation,  on  account  of  depletion. 

In  case  of  a  field  or  territory  fully  developed  and  in  which  no  new  wells 
are  being  drilled,  a  comparison  of  the  quantity  of  oil  or  gas  produced  dur- 
ing the  year  for  which  the  computation  is  made  with  the  quantity  pro- 
duced during  the  last  preceding  year,  will  disclose  the  reduction,  and  the 
percentage  thus  indicated  of  the  reduction  in  flow  and  production  of  such 
field,  will  be  the  measure  of  the  depletion  deduction  to  be  taken  by  the 
owner  with  respect  to  the  capital  invested  in  such  field. 

Notwithstanding  the  fact  that  the  drilling  of  new  wells  may  offset  the 
reduction  in  the  production  and  flow  of  the  older  wells  in  the  field  not 
fully  developed,  the  provision  of  the  law  hereinbefore  quoted,  does  not 
authorize,  and  this  office  cannot  permit,  a  depletion  deduction  to  be  taken 
so  long  as  the  flow  and  production  of  the  unit,  be  it  a  well  or  group  of 
wells,  or  the  entire  territory,  is  as  great  during  the  year  for  which  the 
return  is  made  as  it  was  for  the  year  immediately  preceding. 


INCOME    TAX    ON    CORPORATIONS  241 

Statement  to  be  attached  to  the  return. — To  each  return 
made  by  an  individual  or  corporation  owning  and  oper- 
ating oil  or  gas  properties,  there  should  be  attached  a 
statement  showing: 

1.  (a)  the  fair  market  value  of  the  property  (ex- 
clusive of  machinery  equipment,  etc.),  as  of  March  1, 
1913,  if  acquired  prior  to  that  date;  or 

(b)  the   actual   cost   of   the   property   if   acquired 
subsequent  to  that  date; 

2.  How  the  fair  market  value  of  the  property  as  of 
March  1,  1913,  was  ascertained; 

3.  The  quantity  of  oil  or  gas  produced  during  the  year 
for  which  the  return  was  made; 

4.  The  quantity  produced  during  the  year  immedi- 
ately preceding; 

5.  How  the  depletion  deduction  claimed  in  the  return 
was  computed;  whether  upon  the  decline  in  flow  and 
production  of  individual  wells,  groups  of  wells,  or  the 
entire  field;  and 

6.  Any  other  data  which  would  be  helpful  in  deter- 
mining the  reasonableness  of  the  depletion  deduction 
claimed  in  the  return.. 

No  depletion  to  be  deducted  by  lessees. — Individuals 
and  corporations  operating  oil  or  gas  wells  as  lessees 
are  not  permitted  any  deduction  for  depletion  of  the  oil 
or  gas  deposits.  They  may  deduct  annually,  as  a  rental 
payment,  an  aliquot  part  of  any  bonus  paid  for  the 
right  to  enter  upon,  explore,  develop  and  operate  oil 
or  gas  territories. 

Depletion  of  timberland. — Though  the  Income  Tax  law 
does  not  specifically  provide  for  an  allowance  for  the 
depletion  of  timberlands,  the  Treasury  Department  rec- 
ognizes that  the  income  from  the  sale  of  timber  of  the 
lumber  manufactured  from  it  includes  a  return  of  the 
capital  invested  in  the  timberland  and  permits  a  rea- 
sonable deduction  for  the  cost  of  the  timber  sold. 


242  INCOME    AND    FEDERAL    TAX    REPORTS 

This  deduction  may  be  shown  on  the  report  in  any 
one  of  three  ways: 

1.  As  a  deduction  from  the  gross  receipts. 

2.  As  an  expense  of  production. 

3.  As  an  allowance  for  depletion. 

In  order  to  secure  the  benefit  of  the  deduction  the 
individual  or  corporation  must  comply  with  the  same 
bookkeeping  requirements  as  described  in  the  preceding 
paragraphs  in  the  case  of  mines. 

The  method  of  determining  the  amount  of  the  deduc- 
tions is  also  the  same  as  in  the  case  of  mines.  The 
fair  market  value  as  of  March  1,  1913,  of  the  timber- 
land  en  bloc  must  be  estimated,  unless  the  timberland 
was  acquired  subsequent  to  that  date,  in  which  case  the 
actual  cost  must  be  used.  An  estimate  must  be  made 
of  the  number  of  board  feet  in  the  entire  timber  hold- 
ings. Dividing  the  fair  value  (as  of  March  1,  1913,  or 
the  cost  if  acquired  subsequent  to  that  date),  by  the 
number  of  board  feet  gives  the  cost  per  foot  of  the 
timber.  The  cost  per  foot  multiplied  by  the  number  of 
feet  logged  during  the  year  for  which  the  return  is 
made  will  give  the  amount  which  may  be  deducted 
either  as  a  cost  of  operations  or  as  an  allowance  for 
depletion. 

No  deduction  will  be  permitted  after  the  original 
cost,  or  the  fair  market  value  as  of  March  1,  1913,  is 
extinguished. 

The  total  amount  realized  for  the  logged-ofT  lands  or 
other  salvage  should  be  returned  as  income  in  the  year 
in  which  such  lands  were  disposed  of,  or  in  the  year 
in  which  payment  was  received,  according  to  the  basis 
upon  which  the  income  accounts  are  kept. 

Depletion  of  land. — As  hereinbefore  stated,  land  used 
in  agriculture  is  subject  to  depletion  in  the  form  of 
loss  of  fertility.  The  determination  of  the  loss  due  to 
this  depletion  is  apt  to  be  difficult.  The  Treasury  De- 
partment has  not  as  yet  issued  any  regulations  as  to 


INCOME    TAX   ON    CORPORATIONS  243 

the  method  of  determining  the  deduction  for  depletion. 
In  the  absence  of  any  instructions  the  taxpayer  should 
rely  upon  his  own  judgment.  In  all  such  cases  the  de- 
duction should  be  supported  by  a  statement  showing  in 
detail  how  it  was  calculated. 

Reserves  deductible  by  insurance  companies. — The  In- 
come Tax  law,  section  12,  subdivison  (a),  provides  for 
the  deduction  of,  "in  the  case  of  insurance  companies 
the  net  addition,  if  any,  required  by  law  to  be  made 
within  the  year  to  reserve  funds  and  the  sums  other 
than  dividends  paid  within  the  year  on  policy  and  an- 
nuity contracts." 

The  proper  calculation  of  this  deduction  depends 
upon  the  requirements  of  the  laws  of  the  various  States 
in  which  the  insurance  company  operates.  A  number 
of  cases  have  arisen  on  the  question  of  the  require- 
ments of  the  various  State  laws,  among  which  may  be 
mentioned  Maryland  Casualty  Co.  vs.  United  States, 
decided  by  the  Court  of  Claims,  February  12,  1917,  and 
McCoach  vs.  Insurance  Company  of  North  America, 
decided  by  the  United  States  Supreme  Court,  June  11, 
1917. 

Where  the  reserve  requirements  of  the  States  in 
which  the  company  operates  differ,  the  amount  which 
may  be  deducted  is  the  highest  amount  required  by 
any  of  the  States. 

INTEREST 

Limitations  upon  the  amount  of  interest  deductible. — 
With  certain  exceptions,  interest  paid  (or  accrued  in 
cases  where  the  corporation  keeps  its  books  upon  an 
accrual  basis)  by  a  corporation  on  its  indebtedness  is 
deductible  only  to  the  extent  of  interest  on  so  much  of 
the  indebtedness  as  is  not  in  excess  of  the  sum  of: 

(a)  the  par  value  of  the  entire  amount  of  the  paid- 
up  capital  stock  outstanding  at  the  end  of  the  year;  or 
if  the  capital  stock  has  no  par  value,  or  if  the  company 


244  INCOME    AND    FEDERAL    TAX    REPORTS 

has  no  capital  stock,  the  entire  amount  of  the  capital 
employed  in  the  business  at  the  close  of  the  year,  and 

(b)  one-half  of  its  interest-bearing  indebtedness  then 
outstanding. 

This  arbitrary  limitation  often  has  the  effect  of  tax- 
ing corporations  upon  income  which  they  have  not 
earned.  It  is  particularly  severe  upon  corporations  or- 
ganized with  a  small  capital.  In  one  case,  the  tax 
assessed  was  greater  than  the  actual  net  income  of  the 
corporation.  The  constitutionality  of  this  provision 
has,  however,  been  upheld  by  the  United  States  Su- 
preme Court  in  a  number  of  cases. 

Interest  not  subject  to  restriction. — The  severity  of  the 
limitation  as  imposed  by  the  act  of  October  3,  1913,  has 
been  lessened  by  changes  in  the  act  of  September  8, 
1916,  exempting  certain  classes  of  interest  payments 
from  the  limitation.  These  classes  of  interest  payments 
are  three  in  number: 

1.  Interest  paid  for  the  use  or  possession  of  prop- 
erty to  which  the  corporation  has  not  taken  or  is  not 
taking  title,  or  in  which  it  has  no  equity. 

2.  Interest  paid  on  indebtedness  wholly  secured  by 
property  collateral,  which  is  the  subject  of  sale  or 
hypothecation  in  the  ordinary  business  of  the  corpora- 
tion. 

3.  Interest  paid  on  deposits,  or  on  moneys  received 
for  investment  and  secured  by  interest-bearing  cer- 
tificates of  indebtedness  by  banks,  banking  associations, 
and  loan  or  trust  companies. 

Interest  not  deductible. — Interest  on  obligations  in- 
curred for  the  purchase  of  obligations  or  securities  the 
interest  upon  which  is  entirely  exempt  from  the  income 
tax  is  not  deductible.  This  would  include  the  interest 
on  all  obligations  of  the  States  or  any  subdivision  of  a 
State  and  any  of  the  obligations  of  the  United  States, 
including  interest  on  Liberty  3^28  and  4s.  No  super- 
tax being  imposed  upon  corporations,  and  the  interest 
on  liberty  bonds  being  subject  only  to  the  super-tax, 


INCOME    TAX    ON    CORPORATIONS  245 

in  the  hands  of  corporations  such  interest  is  entirely 
exempt. 

Interest  paid  for  the  use  or  possession  of  property. — A 
corporation  may  rent  property  under  a  lease  the  terms 
of  which  require  the  lessee  corporation  to  pay,  as  a 
rental  equivalent,  the  interest  on  the  bonds  of  the  lessor 
company.  The  amount  of  interest  so  paid  may  be  de- 
ducted as  a  rental  payment,  as  hereinbefore  explained. 

If,  however,  the  lessee  corporation  assumes  the  out- 
standing bonds  of  the  lessor  corporation,  such  bonds 
will  be  considered,  for  the  purpose  of  the  income  tax, 
to  be  part  of  the  lessee  corporation's  own  indebtedness, 
and  the  interest  paid  on  such  bonds  will  be  considered 
as  interest  paid  on  the  indebtedness  of  the  lessee  cor- 
poration. 

Interest  on  indebtedness  wholly  secured  by  property  col- 
lateral the  subject  of  sale  or  hypothecation  in  ordinary 
business. — Section  12,  subdivision  (a),  provides:  "That 
in  the  case  of  indebtedness  wholly  secured  by  property 
collateral,  tangible  or  intangible,  the  subject  of  sale  or 
hypothecation  in  the  ordinary  business  of  such  corpora- 
tion, joint  stock  company  or  association  as  a  dealer 
only  in  the  property  constituting  such  collateral,  or  in 
loaning  the  funds  thereby  procured,  the  total  interest 
paid  by  such  corporation,  company  or  association 
within  the  year  on  an  such  indebtedness  may  be  de- 
ducted as  part  of  its  expenses  of  doing  business,  but 
interest  on  indebtedness  shall  only  be  deductible  on  an 
amount  of  such  indebtedness  not  in  excess  of  the  actual 
value  of  such  property  collateral." 

The  clearest  statement  as  to  what  indebtedness  falls 
within  the  above  provision  is  found  in  T.  D.  1993, 
which  states  that  "the  only  corporations,  joint  stock 
companies,  or  associations,  which  will  be  allowed  un- 
der this  proviso,  as  herein  interpreted,  to  deduct  as 
an  expense  of  doing  business  interest  paid  on  indebt- 
edness wholly  secured  by  mortgage  on  real  estate,  or 
other  physical  property,  are  those  corporations,  joint 


246  INCOME    AND    FEDERAL    TAX   REPORTS 

stock  companies  or  associations  which  are  organized 
and  operated  for  the  exclusive  purpose  of  buying,  sell- 
ing and  dealing  in  the  particular  kind  of  property  upon 
which  the  mortgage  is  given,  and  the  particular  prop- 
erty pledged  for  the  debt  upon  which  the  interest  is 
paid  must  be  the  subject  of  sale  in  the  ordinary  busi- 
ness of  the  corporation. 

"Any  corporation  whose  indebtedness  is  secured  by 
a  trust  mortgage,  or  by  any  form  of  indenture  which 
covers  and  includes  in  the  lien  any  property,  which  is 
not  the  subject  of  sale  in  the  ordinary  business  of  such 
corporation,  will  be  and  is  excluded  from  the  benefit  of 
this  proviso,  and  its  interest  deduction  will  be  limited 
to  the  amount  authorized  in  subdivision  third  [quoted 
on  the  preceding  page]." 

Amount  of  indebtedness  secured  by  collateral  to  be  shown 
separately. — In  order  to  take  advantage  of  the  provision 
permitting  the  deduction  of  interest  on  its  indebtedness 
secured  by  collateral,  corporations  are  required  to  show 
the  amount  of  such  indebtedness  in  a  supplementary 
statement,  which  should  be  separated  from  the  state- 
ment of  the  amount  of  indebtedness  which  is  not  so 
secured  and  the  interest  on  which  is  deducted  as  inter- 
est paid. 

Interest  paid  by  banks  on  deposits. — The  Income  Tax 
law  section  12,  subdivision  (a)  provides  further  that:  "In 
the  case  of  a  bank,  banking  association,  loan  or  trust  com- 
pany, interest  paid  within  the  year  on  deposits  on  moneys 
received  for  investment  and  secured  by  interest-bear- 
ing certificates  of  indebtedness  issued  by  such  bank, 
banking  association,  loan  or  trust  company,  shall  be 
deducted." 

To  come  within  this  provision 

1.  The  corporation  must  be  organized  as  a  bank  or 
banking  institution. 

2.  The  interest  must  be  paid  on  money  deposited  or  on 
money  received  for  investment. 

The  corporation  must  be  organized  as  a  banking-  insti- 


INCOME    TAX    ON    CORPORATIONS  247 

tution. — The  corporation  must  be  organized  as  a  bank 
or  trust  company.  Corporations  receiving  deposits  from 
their  employees  and  paying  interest  thereon  are  not 
permitted  to  deduct  such  interest  as  interest  paid  on 
deposits,  but  must  deduct  it  as  interest  paid,  subject 
to  the  limitation  on  such  deduction. 

Interest  must  be  paid  on  deposits. — The  interest,  in  or- 
der to  come  within  the  above  provision,  must  be  paid 
on  moneys  deposited  or  on  moneys  received  for  invest- 
ment secured  by  interest-bearing  certificates  of  indebt- 
edness. The  obligation  on  which  the  interest  is  paid 
must  be  the  obligation  of  the  corporation  itself. 

In  the  case  of  Middlesex  Banking  Co.  vs.  Eaton  (221 
Fed.,  86)  (affirmed  233  Fed.,  87)  the  court  held  that  a 
corporation  selling  debenture  bonds  and  guaranteed 
real  estate  securities  by  a  method  by  which  it  both  paid 
and  received  interest,  the  difference  between  the 
amounts  paid  and  the  amounts  received  being  its  gross 
income,  was  not  paying  interest  on  deposits  and  there- 
fore was  not  permitted  to  deduct  the  interest  paid  as 
interest  paid  on  deposits.  In  this  case  the  corporation 
would  be  permitted  to  deduct  the  interest  as  paid  on 
indebtedness  secured  by  collateral  the  subject  of  sale, 
the  mortgages  being  considered  the  collateral. 

CALCULATING  THE  AMOUNT  OF  INTEREST  DEDUCTIBLE 

Factors  to  be  considered. — All  interest  paid  by  the  cor- 
poration, unless  it  comes  within  the  classes  mentioned 
in  the  preceding  paragraphs,  is  deductible  only  to  the 
extent  provided  by  the  law.  The  amount  which  may  be 
deducted  as  interest  paid  on  indebtedness  depends  on 
three  factors: 

1.  The  amount  of  paid  up  capital  stock  outstanding 
(if  no  capital  stock  the  amount  of  capital  employed  in  the 
business)  at  the  end  of  the  year. 

2.  The  amount  of  interest-bearing  indebtedness  out- 
standing at  the  end  of  the  year. 

3.  The  contract  rate  of  interest. 

Capital  stock  outstanding  at  the  end  of  the  year. — "Paid- 


248  INCOME    AND    FEDERAL    TAX    REPORTS 

up  capital  stock  outstanding  at  the  close  of  the  year," 
when  used  in  connection  with  the  limitation  on  the  in- 
terest deduction  means  the  par  value  of  the  shares  is- 
sued and  outstanding  on  the  last  day  of  the  year  for 
which  the  return  is  made  and  which  have  been  fully 
paid  up.  Preferred  capital  stock  must  be  included  as 
capital  stock  outstanding,  and  the  dividends  thereon 
may  not  be  deducted  as  interest. 

The  term  "issued  and  outstanding"  does  not  include 
any  treasury  stock;  that  is,  stock  issued  and  subse- 
quently acquired  by  the  corporation.1  But  the  stock 
which  is  part  paid  should  be  included  to  the  extent  of 
the  payments  in  the  stock.  It  makes  no  difference 
whether  such  stock  is  issued  or  not.  Thus,  in  the  case 
of  stock  sold  payable  in  installments  at  definite  times  or 
as  assessed,  only  so  much  as  has  been  actually  paid  in 
on  the  stock  should  be  reported. 

In  the  case  of  shares  issued  without  par  value,  the 
amount  of  the  capital  stock  outstanding  will  be  the 
amount  actually  received  for  such  shares  when  they 
were  issued. 

If  such  shares  are  issued  as  a  bonus  in  connection 
with  shares  of  preferred  stock,  which  must  necessarily 
have  a  par  value,  the  entire  capital  paid  in  is  repre- 
sented by  the  par  value  of  the  preferred  stock.  The 
"paid-up  capital  stock"  will  be  the  par  value  of  the 
preferred  stock. 

If  both  common  and  preferred  stock  are  issued  for 
cash  or  its  equivalent,  the  paid-up  capital  stock  will  be 
the  par  value  (if  fully  paid  in)  of  the  preferred  stock 
plus  the  amount  actually  paid  in  on  the  shares  issued 
without  par  or  nominal  value. 

Capital  employed  in  the  business. — If  the  corporation  has 
no  capital  stock  the  amount  of  capital  actually  employed 
in  the  business  at  the  end  of  the  year  should  be  used  in 
determining  the  amount  of  interest  deductible. 

i  As  used  in  the  Capital  Stock  tax  regulations  "outstanding"  is  held  to 
include  treasury  stock. 


INCOME   TAX   ON    CORPORATIONS  249 

Capital  employed  in  the  business,  as  here  used,  means 
the  entire  capital  paid  in  by  the  members  of  the  company, 
including  so  much  of  the  accumulated  surplus  as  is 
actually  employed  in  the  business,  but  does  not  include 
any  borrowed  capital. 

Interest-bearing  indebtedness  outstanding  at  close  of  year. 
— The  interest-bearing  indebtedness  outstanding  at  the 
end  of  the  year  does  not  include  preferred  stock.  Bonds 
secured  by  property  which  the  corporation  has  leased 
and  which  have  been  assumed  by  the  lessee  corporation 
should  be  included.  Such  overdue  accounts  payable,  on 
which  the  corporation  is  obligated  to  pay  interest,  may 
be  included  as  interest-bearing  indebtedness.  There 
should  be  attached  to  the  return  a  statement  of  the 
amount,  character,  and  the  contract  rate  of  interest  of 
each  item  of  the  indebtedness. 

Calculating  the  amount  of  interest  deductible. — The  sum 
of  the  outstanding  capital  stock  plus  one  half  of  the  out- 
standing interest-bearing  indebtedness  is  the  maximum 
amount  on  which  the  interest  paid  may  be  deducted. 

Where  the  indebtedness  bears  interest  at  various 
rates,  the  indebtedness  bearing  the  highest  rate  may 
be  considered  first  in  computing  the  deduction. 

The  method  of  computing  the  deduction  is  illustrated 
by  the  following  example: 

A  corporation's  paid-in  capital  stock  outstanding  on 
December  31,  1917,  is  as  follows: 

1,000  shares  common  par  $100 $100,000 

500  shares  preferred  par  $100 50,000 

Total  capital  stock $150,000 

The  outstanding  indebtedness  is  as  follows: 
$150,000  First  mortgage  4±/2  per  cent  bonds 
100,000  Second  mortgage  5  per  cent  bonds 
75,000  Debenture  bonds — 6  per  cent 
50,000  3-year — 6  per  cent  notes 

$375,000  Total    interest   bearing   indebtedness 


250  INCOME    AND    FEDERAL    TAX    REPORTS 

Total  capital  stock  outstanding $150,000 

One-half   of  the  interest-bearing  in- 
debtedness         187,500 

Total  indebtedness  upon  which  inter- 
est paid  is  deductible  $337,500 

Interest  deductible: 

6      per  cent  on  $50,000 $3,000.00 

6      per  cent  on    75,000 4,500\00 

5      per  cent  on  100,000 5,000.00 

4y2  per  cent  on  112,500 5,062.50 

$337,500  $17,562.50 

The  maximum  amount  of  interest  which  may  be  de- 
ducted is,  therefore,  $17,562.50. 

TAXES 

Taxes  paid  within  the  year  deductible. — All  taxes  paid 
or  accrued  within  the  year  imposed  by  the  authority  of 
the  United  States  or  its  territories,  or  possessions,  or 
any  foreign  government,  or  under  the  authority  of  any 
State  or  any  subdivision  thereof,  are  deductible,  with 
the  following  exceptions: 

1.  Taxes  assessed  against  local  benefits. 

2.  Income  taxes  imposed  by  the  United  States.1 

3.  Excess  profits  taxes  imposed  by  the  United  States. 

Income  taxes  paid  in  1917  are  not  allowed  as  a  de- 
duction by  the  amendments  to  the  act  of  September 
8,  1916.  Those  corporations  which  accrued  their  in- 
come taxes  on  their  returns  for  any  period  prior  to 
January  1,  1917,  were  permitted  the  deduction  under 
the  original  provisions  of  the  act  of  September  8,  1916. 
The  amendment  of  October  3,  1917,  is,  however,  retro- 
active to  January  1,  1917.  All  corporations  which  ac- 
crued their  income  taxes  on  their  income  tax  returns 
for  any  period  ending  in  1917  are  subject  to  an  addi- 
tional tax  on  such  an  amount. 

i  Income  taxes  paid  to  foreign  Governments  are  deductible. 


INCOME    TAX    ON    CORPORATIONS  251 

Excess  profits  taxes,  while  not  allowed  by  the  law 
as  a  deduction,  are  permitted  as  a  credit.  This  distinc- 
tion between  deduction  and  credit  is  made  in  the  law 
because  the  net  income  of  the  corporation  may  be  sub- 
ject to  an  excess  profits  tax.  The  amount  of  the  excess 
profits  tax  assessed  on  this  net  income  is  to  be  deducted 
before  computing  the  income  tax. 

State  taxes  paid. — State  franchise  and  State  income 
taxes  paid  to  any  State  come  within  the  definition  of 
"taxes  paid  to  any  State"  and  may  be  deducted. 

Prepaid  taxes. — If  a  tax  payment  made  in  the  present 
period  is  partly  or  entirely  for  the  benefit  of  future 
periods,  and  the  corporation  keeps  its  accounts  on  an 
accrual  basis,  only  so  much  of  the  taxes  paid  as  are  for 
the  present  period  may  be  deducted.  Taxes  paid  for 
the  benefit  of  future  periods  should  be  carried  on  the 
books  as  a  deferred  asset  and  charged  off  as  an  expense 
during  the  future  periods.  For  example,  a  corporation 
pays  a  tax  of  twenty  cents  for  each  hundred  dollars  par 
value  of  bonds  it  owns  for  the  purpose  of  having  them 
exempted  from  a  municipal  personal  property  tax  for 
a  period  of  five  years.  In  that  case  four  cents  for  each 
hundred  dollars  par  value  of  bonds  so  exempted  should 
be  deducted  as  an  expense  during  each  of  the  five  years. 

Taxes  paid  by  banks  for  stockholders. — Taxes  paid  by 
banks  or  other  corporations  on  the  value  of  their  capital 
stock  outstanding  and  in  the  hands  of  their  stockholders 
are  not  deductible.  Such  taxes  are  a  primary  liability 
of  the  stockholder  and  as  such  are  chargeable  against 
the  income  of  the  individual  and  not  against  the  income 
of  the  corporation. 

Taxes  paid  on  tax-free  covenant  bonds. — Where  a  cor- 
poration, pursuant  to  a  guarantee  in  its  bonds  that  the 
interest  on  the  bonds  will  be  paid  without  any  deduction 
for  taxes  assessed  against  them,  pays  the  income  tax 
on  such  interest,  it  may  not  deduct  the  taxes  so  paid. 


CHAPTER  X 

INCOME  TAX  ON  CORPORATIONS 
RATE  OF  TAX  AND  RETURNS 

Rate  of  income  tax. — The  act  of  October  3,  1913,  im- 
posed a  tax  of  1  per  cent  on  the  entire  net  income,  ex- 
clusive of  interest  on  bonds  of  the  United  States,  of  any- 
State  or  any  subdivision  of  a  State.  The  act  of  Sep- 
tember 8,  1916,  changed  the  rate  of  tax  to  2  per  cent. 

The  act  of  October  3,  1917,  imposed  an  additional  tax 
of  4  per  cent  upon  the  net  income  of  corporations,  but 
provided  that  for  the  purpose  of  this  tax  dividends  re- 
ceived on  stock  of  corporations  which  were  themselves 
subject  to  the  income  tax  could  be  deducted. 

For  the  year  1917,  therefore,  corporations  will  be 
taxed  at  the  rate  of  6  per  cent  on  net  income  exclusive 
of  dividends  and  at  the  rate  of  2  per  cent  on  income  re- 
ceived in  the  form  of  dividends. 

Additional  10  per  cent  tax. — In  addition  to  this  tax 
the  corporation  may  be  subject  to  an  additional  tax  of 
10  per  cent  on  such  of  its  income  as  is  neither  invested 
in  nor  retained  for  the  reasonable  requirements  of  the 
business  of  the  corporation.  This  additional  tax  is  im- 
posed by  the  amendment  of  October  3,  1917. 

This  amendment  imposes  a  tax  of  ten  per  cent  upon 
such  part  of  the  net  income  of  every  corporation  as 
remains  undistributed  six  months  after  the  close  of 
its  calendar  or  fiscal  year. 

The  tax  will  not  be  levied  if  the  undistributed  net  in- 
come is: 

1.  Invested  or  employed  in  the  business,  or 

2.  Retained  for  employment  in  the  reasonable  require- 
ments of  the  business,  or 

252 


INCOME    TAX   ON    CORPORATIONS  253 

3.  Invested  in  obligations  of  the  United  States  issued 
after  September  1,  1917. 

The  intention  of  this  provision  is  the  same  as  that 
which  appeared  in  the  act  of  October  3,  1913,  and  which 
provided  that  the  income  of  individuals  for  the  purpose 
of  the  super-tax  would  be  held  to  include  their  undis- 
tributed share  of  the  profits  of  any  corporation  which 
was  permitting  its  profits  to  accumulate  beyond  the 
reasonable  requirements  of  the  business. 

This  provision  is  not  intended  to  compel  corporations 
to  pay  out  their  income  in  dividends.  The  fact  that  a 
corporation  does  not  pay  any  dividends,  but  uses  its  in- 
come to  expand  its  business,  does  not  make  it  subject 
to  the  tax.  But  corporations  which  retain  their  income 
beyond  the  reasonable  requirements  of  the  business  for 
the  purpose  of  evading  the  surtaxes  imposed  upon  the 
income  of  the  individual  stockholders  would  be  subject 
to  this  tax. 

The  granting  of  excessive  loans  to  stockholders  or  the 
excessive  investment  in  tax-exempt  securities  would  be 
evidence  of  the  retaining  of  income  beyond  the  reason- 
able requirements  of  the  business.  In  all  cases  the 
question  as  whether  or  not  the  income  is  properly  re- 
tained is  to  be  passed  upon  by  the  Secretary  of  the 
Treasury.  To  enable  him  to  determine  this,  income  tax 
form  1031  requires  corporations  to  show  how  much  of 
their  income  for  the  preceding  taxable  year  remained  un- 
distributed at  the  close  of  that  year,  and  three  and  six 
months  thereafter. 

Rate  of  tax  when  fiscal  year  is  established. — Where  a 
corporation  has  established  a  fiscal  year  other  than  the 
calendar  year  and  the  rates  in  effect  for  the  calendar 
years  covered  by  the  fiscal  year  differ,  the  income  of 
the  fiscal  year  should  be  apportioned  as  between  the 
two  calendar  years  in  which  it  lies  and  the  rate  of  tax 
in  effect  for  each  of  the  calendar  years  should  be  ap- 
plied to  such  part  of  the  income  as  is  determined  to  be 
earned  within  each  calendar  year.    The  apportioning  of 


254  INCOME    AND    FEDERAL    TAX    REPORTS 

the  income  must  be  on  the  basis  of  the  number  of 
months  of  the  fiscal  year  falling  within  each  of  the 
calendar  years.     To  illustrate: 

The  X  Y  Z  Corporation's  fiscal  year  ends  October 
31st.  Its  income  for  the  year  ended  October  31,  1917, 
was  $120,000.  This  income  should  be  apportioned  as  be- 
tween 1916  and  1917;  two-twelfths,  or  $20,000,  is  held 
to  be  earned  in  1916  and  the  remaining  ten-twelfths,  or 
$100,000,  as  earned  in  1917;  $20,000  of  the  income  of  the 
corporation  will  be  subject  only  to  the  2  per  cent  tax 
imposed  by  the  1916  law. 

Act  of  October  3,  1917,  retroactive  to  January  1,  1917. — 
The  additional  tax  imposed  by  the  act  of  October  3, 
1917,  applies  to  income  of  corporations  for  the  entire 
year  of  1917.  Corporations  which  have  filed  a  return 
for  a  fiscal  year  ending  within  the  calendar  year  1917 
will  be  assessed  an  additional  tax  of  4  per  cent  on  such 
portion  of  their  income,  exclusive  of  dividends,  as  is 
held  to  be  earned  in  1917. 

This  tax  will  be  assessed  against  all  corporations,  and 
in  the  case  of  corporations  which  have  dissolved  subse- 
quent to  the  filing  of  their  returns,  the  government  will 
look  first  to  the  officers,  then  to  the  directors,  and  fail- 
ing here,  to  the  stockholders.  It  would  seem,  however, 
that  only  the  stockholders  would  have  any  legal  liability 
to  pay  such  a  tax,  and  then  only  in  case  they  had  re- 
ceived a  distribution  of  the  assets  of  the  corporation. 

Tax  rates  on  dividends. — As  stated  in  the  discussion  of 
income  from  dividends,  dividends  are  to  be  taxed  at  the 
rates  in  effect  for  the  year  in  which  the  surplus  or 
profits  out  of  which  they  are  paid  were  earned.  For 
the  years  1913,  1914  and  1915,  the  rate  of  tax  on  in- 
come in  the  form  of  dividends  was  at  one  per  cent.  For 
the  years  1916  and  1917  dividends  were  taxed  at  2  per 
cent.  " 

Dividends  received  in  1917,  but  paid  out  of  profits 
earned  in  1913,  1914  or  1915  should  be  taxed  only  at 
the  rate  of  one  per  cent.    The  rules  for  determining  out 


INCOME    TAX    ON    CORPORATIONS  255 

of  which  year's  income  a  dividend  is  paid  are  laid  down 
in  the  discussion  referred  to  above.1 

RETURNS 

Returns  may  be  made  for  calendar  or  fiscal  year. — A 
corporation  may  report  its  income  either  for  a  calendar 
year  or  for  a  fiscal  year.  If  it  makes  its  return  on 
the  basis  of  a  fiscal  year,  the  corporation  must  file  a 
notice  of  its  intention  with  the  collector  of  internal  reve- 
nue for  the  district  in  which  it  has  its  principal  office, 
at  least  30  days  before  March  1,  of  the  year  in  which 
the  return  would  otherwise  be  required  to  be  filed. 

Changing  from  calendar  to  fiscal  year. — Where  a  cor- 
poration has  made  its  previous  return  or  returns  on 
the  basis  of  a  calendar  year  and  desires  to  file  its  re- 
turns on  the  basis  of  a  fiscal  year,  it  must  file  a  notice 
designating  the  fiscal  period  not  less  than  thirty  days 
prior  to  March  1,  of  the  year  the  calendar  year  report 
would  otherwise  he  required  to  be  filed  in  and  make  a 
return  on  or  before  March  1  of  the  income  between 
January  1,  and  the  fiscal  date  of  the  preceding  year. 

To  illustrate: 

1.  The  last  income  return  was  filed  March  1,  1917, 

for  the  calendar  year  1916. 

2.  It  was  determined  to  establish  June  30,  as  the 

end  of  the  fiscal  year. 
In  such  a  case  it  will  be  necessary  to : 

1.  File  notice  of  the  new  fiscal  year  not  later  than 

January  29,  1918. 

2.  A  return  must  be  filed  on  or  before  March  1, 

1918,  for  income  from  January  1,  1917  to  June 
30,  1917. 

3.  A  return  must  be  filed  on  or  before  August  29, 

1918,  for  the  fiscal  period  July  1,  1917  to  June 
30,  1918. 
Returns  required  of  all  corporations. — The  duty  to  make 
a  return  exists  regardless  of  whether  there  is  any  in- 

i  See  pages  78-88. 


256  INCOME   AND   FEDERAL    TAX   REPORTS 

come  or  not.  Every  corporation  or  business  association 
in  existence,  not  specifically  enumerated  as  exempt  shall 
make  a  return  of  net  income  whether  or  not  there  is 
any  income  liable  to  tax.  This  applies  to  new  corpora- 
tions and  corporations  which  have  gone  out  of  business 
during  the  year. 

Subsidiary  corporations  are  considered  as  separate 
corporations  and  must  render  separate  returns. 

When  the  name  of  a  corporation  is  changed  it  is  not 
considered  a  new  corporation.  The  fact  that  the  name 
had  been  changed  should  be  noted  on  the  return. 

If  a  distinct  new  corporation  was  organized  to  take 
over  the  property  of  the  old,  both  corporations  will  be 
required  to  make  separate  returns  covering  the  period 
of  the  year  that  each  respectively  was  operating  the 
business. 

Receivers,  trustees  in  bankruptcy,  or  assignees  must 
make  returns  for  the  corporation  whose  property  or 
business  they  are  operating. 

When  return  must  be  filed. — Returns  of  net  income  for 
the  calendar  year  must  be  filed  on  or  before  March  1 
of  the  following  year.  The  time  for  filing  returns  for  the 
year  1917,  however,  has  been  extended  to  April  1,  1918. 

Returns  of  net  income  for  a  fiscal  year  must  be  filed 
within  60  days  after  the  close  of  the  fiscal  year  for 
which  the  return  is  made. 

The  return  must  be  placed  in  the  United  States  mails, 
properly  addressed  with  postage  paid,  so  that  there 
will  be  ample  time  to  reach  the  office  of  the  collector 
in  the  district  wherein  is  located  the  principal  place  of 
business  of  the  corporation  on  or  before  the  last  day 
upon  which  the  return  is  due.  When  the  last  day  is  a 
Sunday  or  legal  holiday  the  next  day  following  will  be 
considered  the  last  day. 

Tentative  returns. — All  corporations,  if  unable  to  as- 
semble the  data  in  time  to  make  the  return  within  the 
prescribed  time  may  advise  the  collector  of  this  fact 
and  file  a  tentative  return  approximating  the  income  of 


INCOME    TAX    ON    CORPORATIONS  257 

the  year.  This  tentative  return  must  be  substituted  by 
a  true  and  accurate  return  as  soon  as  the  actual  figures 
are  available. 

Extensions  of  time,  assessment  and  payment  of  tax. — All 
the  provisions  regarding  the  granting  of  extensions  of 
time  for  the  filing  of  returns,  the  assessment  and  pay- 
ment of  taxes  explained  in  connection  with  the  indi- 
vidual returns  apply  equally  to  corporations  and  are 
therefore  not  repeated  in  this  chapter. 

The  Preparation  of  Form  1031. — Gross  Income  is  to  be  reported  under 
five  headings  as  follows:  (1)  Gross  sales  and  other  income  from  opera- 
tions (pp.  181-189)  ;  (2)  Income  from  rentals,  royalties,  etc.  (pp.  191-193)  ; 
(3)  Income  from  interest  (pp.  194-195);  (4)  Income  from  dividends  (pp. 
195-198);  (5)  Income  from  all  other  sources  (pp.  198-205).  The  item 
"Gross  sales  and  other  income  from  operations"  is  the  gross  receipts  from 
sales  or  other  operations.  The  cost  of  such  sales  is  to  be  reported  under 
deductions  as  an  expense  of  business. 

Deductions  are  divided  into  four  classes:  (1)  Cost  of  goods  sold  and 
expenses  of  business  (pp.  181-188  and  206-216)  ;  (2)  Losses  charged  off, 
including  depreciation  and  depletion  (pp.  217-342);  (3)  Interest  paid 
(pp.  243-249);    (4)   Taxes  paid    (pp.  250-251). 

Calculation  of  Tax. — The  total  gross  income  reported  less  the  total  de- 
ductions gives  the  total  net  income  (line  8  of  report).  From  this  amount 
should  be  deducted  the  amount  of  excess  profits  tax  as  determined  either 
on  this  form  or  on  form  1101  (see  Chapter  on  Excess  Profits  Tax)  and 
also  such  dividends  or  parts  of  dividends  as  were  paid  out  of  profits  ac- 
cumulated in  1913,  1914  and  1915.  These  dividends  are  taxable  at  the 
rate  of  1  per  cent.  The  resulting  figure  is  the  amount  of  income  subject  to 
the  2  per  cent  tax  imposed  by  the  act  of  September  8,  1916  (line  9a).  The 
amount  of  dividends  deducted  above  as  earned  in  1913,  1914  or  1915  is 
taxable  at  the  rate  of  1  per  cent,  which  is  the  rate  in  effect  for  those  years 
(line  9b).  Returning  to  the  amount  shown  on  line  8  we  deduct:  1,  the 
amount  of  excess  profits  tax,  and,  2,  the  total  amount  of  dividends  received. 

The  resulting  amount  is  subject  to  the  extra  4  per  cent  tax  imposed  by 
the  act  of  October  3,  1917   (line  11). 

If  the  corporation  reports  on  the  basis  of  a  fiscal  year  the  extra  4  per 
cent  tax  will  be  computed  on  as  many  twelfths  of  the  amount  shown  on 
line  11  as  there  are  months  from  January,  1917,  to  the  close  of  the  fiscal 
year. 

The  total  tax  is  the  sum  of: 

1.  Amount  of  Excess  Profits  Tax; 

2.  Tax  at  2  per  cent  on  amount  on  line  9a; 

3.  Tax  at  1  per  cent  on  amount  on  line  9b; 

4.  Tax  at  4  per  cent  on  amount  on  line  11. 


CHAPTER  XI 

"WITHHOLDING,"   "DEDUCTION" 

AND   "INFORMATION"  AT 

THE  SOURCE 

Prior  to  the  amending  of  the  Income  Tax  law  by  the 
act  of  October  3,  1917,  deduction  at  the  source  was  one 
of  the  basic  features  of  the  collection  of  the  tax. 

"Withholding"  provisions  of  the  1916  Income  Tax  law. — 
Under  the  provisions  of  the  1916  law  all  interest  on 
bonds  and  other  similar  obligations  of  domestic  corpora- 
tions was  subject  to  the  withholding  of  the  normal  tax 
of  2  per  cent,  whether  such  interest  accrued  to  citizens 
and  residents  of  the  United  States  or  to  non-resident 
alien  individuals,  unless  an  exemption  up  to  $3,000  or 
$4,000  was  claimed  by  the  individual.  All  other  forms 
of  periodical  profits  or  income  in  excess  of  $3,000  or 
$4,000  were  subject  to  withholding  of  the  normal  tax  at 
the  rate  of  2  per  cent. 

The  withholding  of  the  tax  at  the  rate  of  2  per  cent 
also  applied  to  interest  on  bonds,  etc.,  of  domestic  cor- 
porations received  by  non-resident  alien  corporations 
and  partnerships. 

Dividends  on  stock  of  domestic  corporations  paid  to 
foreign  corporations  having  no  office  or  place  of  busi- 
ness in  the  United  States  was  also  subject  to  withhold- 
ing at  the  source  at  the  rate  of  2  per  cent. 

The  amendments  made  by  the  act  of  October  3,  1917, 
have  practically  eliminated  withholding  at  the  source,  as 
far  as  citizens  and  residents  of  the  United  States  are 
concerned. 

258 


"WITHHOLDING,"    ETC.,   AT   SOURCE  259 

The  various  provisions  as  to  withholding  at  the  source 
in  effect  on  and  after  October  4,  1917,  may  be  summar- 
ized as  follows: 

Withholding  of  tax  from  payments  made  to  citizens  or 
residents  of  the  United  States. — The  normal  income  tax  is 
not  to  be  deducted  and  withheld  from  any  payment  of 
income  made  to  a  citizen  or  resident  of  the  United 
States  except  when  derived  from  a  bond,  mortgage  or 
other  obligation  issued  by  a  domestic  or  resident  cor- 
poration, which  contains  a  contract  or  provision  by 
which  the  obligor  agrees  to  pay  any  portion  of  the  tax 
imposed  by  the  Federal  Income  Tax  Law  upon  the 
obligee,  or  to  reimburse  the  obligee  for  any  portion  of 
the  tax  which  the  obligor  may  be  required  or  permitted 
to  pay  thereon,  or  to  retain  therefrom,  under  any  law 
of  the  United  States.  That  is,  if  interest  is  paid  upon 
any  obligation  of  a  domestic  or  resident  corporation, 
joint-stock  company,  etc.,  which  contains  a  so-called 
"tax-free"  or  "no  deduction"  clause  to  a  citizen  or  resi- 
dent of  the  United  States  normal  tax  at  the  rate  of  two 
per  cent  is  to  be  withheld,  unless  personal  exemption  is 
claimed  and  then  only  frOm  the  amount  paid  in  excess 
of  the  exemption  claimed. 

Domestic  partnership. — There  is  to  be  no  withholding 
at  the  source  of  any  income  accruing  to  any  domestic 
partnership. 

Domestic  corporations  or  foreign  corporations  having  a 
place  of  business  within  the  United  States. — There  is  no 
withholding  at  the  source  of  any  income  accruing  to  cor- 
porations organized  under  the  laws  of  the  United  States 
or  any  State,  or  to  foreign  corporations  having  an  office 
or  place  of  business  within  the  United  States. 

Income  withheld  from  non-resident  alien  individuals. — All 
persons,  corporations,  partnerships,  associations  or  in- 
surance companies  paying  any  amount  of  fixed  or  de- 
terminable gain,  profit  or  income,  other  than  that  paid 
as  dividends  on  the  capital  stock  or  from  the  net  earn- 


260  INCOME   AND   FEDERAL    TAX   REPORTS 

ings,  profits  or  income  of  corporations,  joint-stock  com- 
panies, etc.,  subject  to  a  like  tax,  to  a  non-resident  alien 
individual  are  required  to  deduct  and  withhold  normal 
tax  at  the  rate  of  two  per  cent  from  the  entire  amount 
paid.  But  salaries  paid  to  non-resident  aliens  for  serv- 
ices rendered  entirely  outside  of  the  United  States  are 
not  subject  to  the  tax  and,  therefore,  no  withholding 
at  the  source  is  required. 

Interest  on  bank  deposits  accruing  to  non-resident 
alien  individuals  is  subject  to  withholding  at  the  rate  of 
2  per  cent. 

Non-resident  partnerships  exempt. — There  is  no  withhold- 
ing at  the  source  of  any  income  accruing  to  any  foreign 
partnership,  regardless  of  the  character  of  the  income. 

Withholding  from  non-resident  corporations. — Normal  in- 
come tax  at  the  rate  of  6  per  cent  is  to  be  withheld  from 
all  payments  of  interest  upon  bonds,  mortgages,  deeds 
of  trust,  or  other  similar  obligations  of  domestic  or 
other  resident  corporations,  joint-stock  companies,  asso- 
ciations or  insurance  companies,  when  paid  to  foreign 
corporations,  joint-stock  companies,  associations  or  in- 
surance companies  having  no  office  or  place  of  business 
in  the  United  States. 

When  dividends  upon  the  capital  stock  or  from  the 
net  earnings  of  domestic  or  other  resident  corporations, 
joint-stock  companies,  associations  or  insurance  com- 
panies, are  paid  to  foreign  corporations,  joint-stock 
companies,  etc.,  having  no  office  or  place  of  business  in 
the  United  States,  normal  tax  at  the  rate  of  2  per  cent 
is  to  be  withheld. 

A  recent  ruling  of  the  Treasury  Department,  however, 
provides  that  interest  on  bank  deposits  paid  to  non-resi- 
dent corporations  is  not  subject  to  withholding  of  the 
tax.  Of  course,  non-resident  corporations  are  neverthe- 
less liable  to  pay  the  tax  on  such  interest. 

The  statements  made  hereinbefore  are  brought  out 
more  clearly  by  the  following  chart: 


"WITHHOLDING,"    ETC.,    AT   SOURCE  261 

Rate  of  tax  to  be  withheld  on  various  items  of  income. 


Recipient 

Interest  on  Bonds 
and  Other  Obli- 
gations of  Domes- 
tic Corporations 

Dividends  on 
Stock  ot  Domes- 
tic Corporations 

Miscellaneous 
Income 

1.  Citizens  and  Resi- 
dents of  the  United 
States 

None* 

None 

None 

2.  Domestic  Partner- 
ships   

None 

None 

None 

3.  Domestic  and  Res- 
ident Corporations 

None 

None 

None 

4.  Non-resident  Alien 
Individuals 

2% 

None 

2% 

5.  Foreign     Partner- 
ships   

Nonef 

None 

None 

6.  Non-resident  Alien 
Corporations 

6% 

2% 

6%t 

Definition  of  the  "United  States." — It  will  be  seen  that 
no  withholding  of  income  applies  to  any  income  accru- 
ing to  any  individual  or  organization  resident  in,  or  a 
citizen  of,  or  organized  in,  the  United  States.  A  defini- 
tion of  the  words  United  States  is  given  in  the  law. 

Section  15  of  the  Income  Tax  Law  provides  "That 
the  word  'States'  or  'United  States'  when  used  in  this 
title  shall  be  construed  to  include  any  Territory,  the 
District  of  Columbia,  Porto  Rico,  and  the  Philippine 
Islands,  when  such  construction  is  necessary  to  carry 
out  its  provisions."  The  law  further  states  in  Section 
23,  "That  the  Provisions  of  this  title  shall  extend  to 
Porto  Eico  and  the  Philippine  Islands;  Provided,  that 
the  administration  of  the  law  and  the  collection  of  the 

*  Interest  on  bonds  containing  tax  free  covenant  clause  is  to  be  paid  by 
issuing  corporation. 

t  According  to  an  informal  decision  of  the  Treasury  Department,  Oct.  20, 
1917,  there  will  be  no  withholding  on  any  income  accruing  to  non-resident 
partnerships.  A  reading  of  section  13,  subdivision  (e),  of  the  law  as  amended 
would  make  it  evident  that  Congress  intended  that  it  should  apply,  but  a 
technical  error  prevents  it  from  applying. 

%  Except  interest  on  bank  deposits.     See  p.  260. 


262        INCOME    AND    FEDERAL    TAX    REPORTS 

taxes  imposed  in  Porto  Rico  and  the  Philippine  Islands 
shall  be  by  the  appropriate  internal  revenue  officers  of 
these  governments,  and  all  revenues  collected  in  Porto 
Rico  and  the  Philippine  Islands  thereunder  shall  accrue 
intact  to  the  general  governments  thereof,  respec- 
tively." 

The  added  War  Income  tax  imposed  by  Title  I  of  the 
act  of  October  3,  1917,  does  not  apply  to  Porto  Rico  or 
the  Philippine  Islands. 

No  tax  will  be  withheld  at  the  source  on  any  income 
accruing  to  any  citizen  or  resident  of  Porto  Rico  or  the 
Philippines  or  to  any  partnership  or  corporation  organ- 
ized in  or  having  an  office  in  Porto  Rico  or  the  Philip- 
pines. 

Procedure  in  "withholding." — The  Income  Tax  law,  sec. 
9,  subdivision  b,  states  that: 

"All  persons,  corporations,  partnerships,  associations  and  insurance  com- 
panies, in  whatever  capacity  acting,  including  lessees  or  mortgagors  of 
real  or  personal  property,  trustees  acting  in  any  trust  capacity,  executors, 
administrators,  receivers,  conservators,  employers,  and  all  officers  and  em- 
ployees of  the  United  States  having  the  control,  receipt,  custody,  disposal 
or  payment  !  .  .  [of  income  subject  to  withholding]  .  .  .  are  hereby  au- 
thorized and  required  to  deduct  and  withhold  from  such  .  .  .  [income] 
.  .  .  such  sum  as  will  be  sufficient  to  pay  the  normal  tax  imposed  thereon 
by  this  title,  and  shall  make  return  therefor  on  or  before  March  1,  of 
each  year  and,  on  or  before  the  time  fixed  by  law  for  the  payment  of  the 
tax,  shall  pay  the  amount  withheld  to  the  officer  of  the  United  States  Gov- 
ernment authorized  to  receive  the  same,  and  they  are  each  made  personally 
liable  for  such  tax,  and  they  are  each  indemnified  against  every  person, 
corporation,  partnership,  association,  or  insurance  company,  or  demand 
whatsoever  for  all  payments,  which  they  shall  make  in  pursuance  and  by 
virtue  of  this  title." 

Every  person  who  under  the  provisions  of  the  law 
is  authorized  to  withhold  taxes  is  required  to  make  an 
annual  return,  which  must  be  filed  on  or  before  March 
1,  of  the  following  year,  with  the  collector  of  internal 
revenue  for  the  district  in  which  the  withholding  agent 
has  his  principal  place  of  business. 

The  return  should  not  be  filed  before  30  days  prior 
to  March  1  (i.e.  Jan.  29),  as  claims  for  deductions  may 


"WITHHOLDING,"    ETC.,   AT   SOURCE  263 

be  filed  with  the  withholding  agent  up  to  that  date  (i.e. 
Jan.  29)  by  the  party  subject  to  withholding. 

From  this  return  an  assessment  is  made  and  a  notice 
sent  to  the  withholding  agent.  The  tax  must  be  paid 
by  June  15th,  and  any  failure  to  pay  the  tax  subjects 
the  withholding  agent  to  the  same  penalty  as  failure  to 
pay  his  regular  income  tax. 

Repayment  of  tax  withheld  during  1917. — The  Income 
Tax  law  as  enacted  September  8,  1916,  provided  for 
withholding  from  citizens  and  residents  of  the  United 
States  the  tax  on  all  interest  from  bonds  and  on  pay- 
ments of  fixed  and  determinable  income  in  excess  of 
$3,000  or  $4,000  as  the  case  might  be,  at  the  rate  of  2 
per  cent.  This  provision  was  in  effect  from  January 
1,  1917,  to  October  3,  1917.  On  Oct.  4,  1917,  the  with- 
holding provision,  in  so  far  as  it  affected  citizens  and 
residents  of  the  United  States,  was  repealed.  All  in- 
come which  was  withheld  at  the  source  (other  than 
interest  on  "tax-free"  bonds)  is  to  be  returned  to  the 
person  entitled  to  same. 

Neither  the  law  nor  the  Treasury  Department  gives 
any  indication  as  to  how  this  is  to  be  done.  Apparently, 
the  individual  entitled  to  the  refund  will  have  to  make 
a  claim  upon  the  Withholding  agent  for  a  refund  of  the 
amount  withheld.  Most  reputable  banks  and  corpora- 
tions have  refunded  any  tax  withheld  to  the  person 
entitled  to  it  without  waiting  for  a  claim  to  be  made 
upon  them. 

Deduction  of  interest  on  bonds  and  other  obligations  of 
domestic  corporations. — Interest  on  bonds  of  domestic  cor- 
porations accruing  to  a  non-resident  alien  individual  is 
subject  to  withholding  at  the  rate  of  2  per  cent. 

Interest  on  bonds  or  other  obligations  of  domestic 
corporations  accruing  to  non-resident  alien  corporations 
is  subject  to  withholding  at  the  rate  of  6  per  cent. 

Interest  on  bonds  of  domestic  corporations  accruing 
to  citizens  or  residents  of  the  United  States  is  not  sub- 


264  INCOME   AND   FEDERAL   TAX   REPORTS 

ject  to  withholding,  but  if  the  bond  contains  a  contract 
or  provision  "by  which  the  obligor  agrees  to  pay  any 
portion  of  the  tax  imposed  by  this  title  upon  the  obligee 
or  to  reimburse  the  obligee  for  any  portion  of  the  tax 
or  to  pay  the  interest  without  deduction  for  any  tax 
which  the  obligor  may  be  required  or  permitted  to  pay 
thereon  or  to  retain  therefrom  under  any  law  of  the 
United  States,"  the  corporation  will  be  required  to  with- 
hold and  pay  over  the  tax.  (War  Income  Tax  Law,  sec. 
9,  c). 

Generally  speaking,  for  the  purpose  of  the  tax  there 
are  two  classes  of  bonds,  registered  and  coupon. 

Eegistered  bonds  are  those  bonds  the  interest  on  which 
is  payable  to  the  registered  owner  of  the  bond. 

Coupon  bonds  are  those  bonds,  the  interest  on  which 
is  payable  by  means  of  interest  coupons  attached  to  the 
bond.  These  coupons  are  dated,  are  in  the  form  of  a 
check,  and  may  be  deposited  in  any  bank  for  credit  and 
collection. 

The  duties  of  the  owner  of  the  bonds,  the  issuing 
corporation  and  the  bank  paying  the  interest,  in  con- 
nection with  registered  bonds,  are  entirely  different 
from  their  duties  in  connection  with  coupon  bonds. 

Duties  of  Issuing  Corporation  in  paying  interest  on  regis- 
tered bond. — The  duty  of  the  corporation  is  to  withhold 
the  tax  at  the  rate  of  2  per  cent  if  the  actual  owner  is 
a  non-resident  alien  individual,  and  at  the  rate  of  6 
per  cent  if  the  actual  owner  is  a  non-resident  alien  cor- 
poration. 

No  tax  need  be  withheld  if  the  actual  owner  of  the 
registered  bonds  is  a  citizen  or  resident  of  the  United 
States,  a  partnership,  either  foreign  or  domestic,  or  a 
domestic  or  resident  corporation  (unless  the  bond  con- 
tains a  tax-free  covenant  clause,  in  which  case  the  tax 
no  doubt  would  be  assumed  by  the  debtor  corporation, 
if  the  owner  were  an  individual,  whether  resident  in 
the  United  States  or  elsewhere). 


"WITHHOLDING,"    ETC.,    AT   SOURCE  265 

The  corporation  is  liable  under  the  provisions  for  with- 
holding of  the  tax  on  the  basis  of  the  record  ownership 
of  the  bonds,  unless  it  receives  notice  that  the  record 
owner  is  not  the  true  owner  and  that  the  true  owner  is 
not  subject  to  withholding.  On  the  other  hand,  the 
corporation  is  under  no  obligation  to  look  beyond  the 
record  owner  to  find  out  whether  or  not  the  true  owner 
would  be  subject  to  withholding,  but  it  is  obliged  to 
withhold  in  case  the  true  owner  is  disclosed  to  it  as 
one  who  is  subject  to  withholding. 

Duty  of  the  record  owner  of  registered  bonds. — If  the 
record  owner  of  the  bond  is  a  non-resident  alien  cor- 
poration and  the  actual  owner  is  a  non-resident  alien 
individual  the  actual  owner  should  file  a  statement  dis- 
closing the  true  ownership.  Upon  receipt  of  this  notice 
the  issuing  corporation  will  withhold  only  at  the  rate 
of  2  per  cent. 

If  the  record  owner  of  the  bond  .is  a  non-resident 
alien  individual  or  corporation  and  the  actual  owner 
is  a  person,  partnership  or  corporation  not  subject  to 
withholding,  the  actual  owner  should  file  a  statement 
of  true  ownership,  in  which  case  the  issuing  corpora- 
tion would  not  withhold  at  all. 

If  the  record  owner  is  an  individual  or  organization 
whose  income  is  not  subject  to  withholding,  and  the 
actual  owner  is  an  individual  or  organization  subject 
to  withholding  (i.e.  a  non-resident  alien  individual  or 
non-resident  alien  corporation)  there  is  no  obligation 
on  the  part  of  the  record  owner  to  reveal  to  the  issuing 
corporation  that  the  actual  owner  is  subject  to  withhold- 
ing. 

As  receiver  of  income  belonging  to  the  non-resident 
alien  individual  or  corporation  (actual  owner)  the  rec- 
ord owner  becomes  the  agent  of  the  actual  owner,  and 
is  required  to  file  a  return  of  the  income  of  the  actual 
owner  that  is  in  his  possession.  This  obligation  to  file 
a  return  for  the  actual  owner  applies  only  if  the  record 


266  INCOME   AND   FEDERAL    TAX    REPORTS 

owner  is  a  citizen  or  resident  of  the  United  States  or  a 
domestic  or  resident  corporation. 

Right  of  actual  owner  of  registered  bonds. — Where  the 
actual  owner  is  a  non-resident  alien  individual  and  the 
record  owner  a  non-resident  alien  corporation,  the  actual 
owner  may  file  a  statement  of  actual  ownership  so  that 
the  tax  will  be  withheld  at  the  rate  of  2  per  cent  instead 
of  at  the  rate  of  6  per  cent. 

If  the  actual  owner  is  not  subject  to  withholding  but 
the  record  owner  is  a  non-resident  alien  individual  or 
corporation,  the  actual  owner  has  the  right  to  file  a 
statement  of  actual  ownership  with  the  issuing  corpora- 
tion so  that  the  tax  will  not  be  withheld. 

Where  the  actual  owner  has  not  taken  advantage  of 
his  right  to  file  a  statement  of  true  ownership,  and  the 
tax  has  been  withheld  in  excess  of  the  actual  owner's 
liability,  he  may  apply  for  a  refund  in  the  manner  de- 
scribed under  "Refund  of  Taxes,"  p.  27. 

Duties  of  banks  in  connection  with  payment  of  interest 
on  registered  bonds. — The  issuing  corporation  is  the  sole 
withholding  agent  for  interest  on  registered  bonds.  No 
duty  as  to  withholding  is  imposed  upon  any  bank  col- 
lecting or  paying  the  interest  on  these  bonds  unless  the 
bank  is  the  paying  agent  of  the  corporation. 

Tax-free  covenant  bonds. — A  large  proportion  of  the 
corporate  mortgages  outstanding  in  the  United  States 
contain  some  form  of  what  is  commonly  known  as  a 
"tax-free"  covenant  clause. 

The  wording  of  these  clauses  differs  in  the  various 
mortgages,  the  most  common  forms  stating  that  the 
corporation  agrees  to  pay  the  interest  without  deduc- 
tion for  any  tax  which  it  may  be  required  to  pay,  or  to 
reimburse  the  holder  for  any  tax  which  he  may  be 
required  to  pay. 

In  the  past  the  Treasury  Department  did  not  take 
official  cognizance  of  the  covenant.  The  tax  was  to  be 
withheld  and  paid  regardless  of  this  clause,  and  the 


"WITHHOLDING,"   ETC.,   AT   SOURCE  267 

adjustment  of  the  tax  liability  was  left  to  be  settled  by 
the  corporation  and  the  bondholder  between  themselves. 

Under  this  ruling  the  burden  of  seeing  that  the  cor- 
poration kept  its  covenant  agreement  was  placed  upon 
the  individual  bondholder.  Corporations  tried  to  break 
their  covenants  on  various  technical  grounds.  A  num- 
ber of  cases  have  been  decided  with  reference  to  the 
wording  of  such  a  clause  as  will  hold  the  corporation 
liable. 

The  amendments  of  October  3,  1917,  give  recognition 
to  these  "tax-free"  covenants  by  providing  that  the  tax 
on  interest  accruing  to  citizens  or  residents  of  the 
United  States  on  bonds  of  domestic  corporations  should 
be  withheld  at  the  source  only  if  the  bonds  contained  a 
"tax-free"  covenant. 

This  withholding  applies  only  if  the  corporation  is 
willing  to  live  up  to  its  covenant. 

This  fact  is  brought  out  in  a  ruling  in  which  it  is 
stated  that  the  issuing  corporation,  and  not  the  bank 
by  whose  agency  collection  is  made,  will  be  required  to 
withhold  the  tax  on  the  interest  on  those  bonds  contain- 
ing the  "tax-free  covenant"  clause.1 

This  leaves  the  decision  as  to  whether  the  tax  should 
be  withheld  entirely  to  the  discretion  of  the  issuing  cor- 
poration. The  government  does  not  attempt  to  say  what 
is,  or  what  is  not  a  tax-free  covenant.  If  the  corpora- 
tion pays  the  tax  it  thereby  admits  that  the  bond  does 
contain  a  tax-free  covenant,  and  must  therefore  pay  the 
bondholder  the  full  interest  without  any  deduction  for 
the  tax.  On  the  other  hand,  if  the  corporation  does  not 
pay  the  tax,  the  bondholder  cannot  claim  any  credit  for 
tax  paid  at  the  source,  and  will  therefore  have  to  pay 
the  tax  himself.  If  the  bondholder  believes  that  the 
bond  contains  a  tax-free  clause  under  which  the  corpora- 

1  If  the  Government  had  not  issued,  this  decision  it  would  have  placed 
the  burden  of  deciding  whether  or  not  any  certain  bonds  contained  a  tax 
free  clause  upon  itself. 


268  INCOME   AND   FEDERAL   TAX   REPORTS 

tion  should  have  paid  the  tax,  he  may  sue  the  corporation 
for  breach  of  its  covenant. 

The  Government's  point  of  view  is  that  there  are 
really  two  transactions  in  connection  with  the  payment 
of  the  tax  on  bonds  containing  the  tax-free  clause.  The 
corporation  withholds  the  tax  on  the  coupon,  paying 
over  to  the  holder  the  face  amount  of  the  coupon,  less 
the  tax.  In  compliance  with  its  covenant  the  corpora- 
tion then  reimburse  the  holder  for  the  amount  of  the  tax. 

In  practice  there  is  only  one  transaction.  The  cor- 
poration pays  the  full  amount  of  the  coupon  to  the 
bondholder,  and  then  pays  the  tax  due  out  of  its  own 
funds. 

In  connection  therewith  the  Treasury  Department 
stated : 

"The  stipulation  whereby  a  corporation  agrees  to  pay 
the  tax  on  interest  from  bonds  is  a  matter  which  con- 
cerns only  the  bondholder  and  the  corporation  issuing 
the  bonds.  The  government  is  concerned  only  with 
the  deducting  and  the  withholding  of  the  tax,  and  the 
question  of  the  amount  to  be  paid  to  the  bondholder  is 
left  for  adjustment  between  him  and  the  debtor  corpora 
ation." 

Duty  of  the  withholding  bank  in  paying  interest  coupons. 
— It  is  the  custom  of  most  corporations  to  appoint  a 
certain  bank  as  their  paying  agent.  This  bank  acts 
as  agent  for  the  corporation,  withholding  the  tax  when 
necessary  and  making  the  return  as  a  withholding  agent. 

The  local  bank  with  which  the  coupon  is  deposited 
acts  only  as  the  collecting  agent  of  the  depositor  and  is 
not  charged  with  any  duties  as  to  withholding.  The  local 
bank  may  credit  its  depositor  with  the  face  amount  of 
the  coupon,  but  such  credit  is  only  a  courtesy  upon  the 
part  of  the  bank,  and  is  subject  to  a  charge  for  any 
tax  which  may  be  withheld  at  the  source. 

As  stated  above,  the  bank  is  not  charged  with  deciding 
whether  or  not  the  bond  contains  a  tax-free  clause,  and 


"WITHHOLDING,"    ETC.,    AT   SOURCE  269 

the  withholding  of  any  tax  because  of  a  tax-free  cove- 
nant should  be  decided  by  the  issuing  corporation. 

The  duty  of  the  bank  is  to  withhold  2  per  cent  on  in- 
terest accruing  to  non-resident  alien  individuals  and  6 
per  cent  on  interest  accruing  to  non-resident  alien  cor- 
porations. 

To  protect  itself  the  paying  bank  should  withhold  at 
the  rate  of  6  per  cent,  unless  the  interest  coupon  is 
accompanied  by  an  ownership  certificate  on  the  proper 
form  showing  that  the  owner  is  not  subject  to  withhold- 
ing at  all,  or  is  subject  to  withholding  only  at  the  rate 
of  2  per  cent.  These*  ownership  certificates  are  turned 
over  to  the  collector  of  internal  revenue,  together  with 
the  withholding  return  Form  1012,  and  should  be  filed 
with  the  collector  within  20  days  following  the  month 
for  which  the  payment  is  made. 

An  annual  report  is  also  required  on  or  before  March 
1,  of  the  following  year,  from  the  withholding  agent, 
which  report  is  a  recapitulation  of  the  monthly  reports, 
and  from  the  former  the  assessment  of  the  tax  against 
the  withholding  agent  is  made. 

When  the  amendments  were  enacted,  October  3,  1917, 
it  was  not  clear  whether  the  withholding  from  non-resi- 
dent alien  corporations  was  meant  to  be  at  the  rate  of 
2  per  cent  or  at  the  rate  of  6  per  cent,  and  a  number 
of  banks  withheld  only  at  the  2  per  cent  rate.  They  are, 
therefore,  now  liable  for  the  difference  between  6  per 
cent  and  2  per  cent  on  all  interest  items  paid  to  non- 
resident alien  corporations  on  and  after  Oct.  4,  1917. 

Whether  or  not  the  bank  should  pay  over  the  full 
amount  of  the  coupon  to  the  holder  in  the  case  of  tax- 
free  covenant  bonds  depends  upon  the  instructions  given 
by  the  issuing  corporation.  As  stated  before,  if  the  cor- 
poration wishes  to  keep  its  covenant  it  must  pay  the 
bondholder  the  full  amount  of  interest  without  any  de- 
duction for  the  tax. 

In   all    cases   where   individuals    or   fiduciaries    own 


270  INCOME   AND   FEDERAL   TAX   REPORTS 

bonds  containing  the  tax-free  covenant  clause,  they 
should  execute  the  proper  certificate  (form  1000)  show- 
ing ownership  of  the  bond  and  coupon,  and  thereby  not 
claiming  exemption.  This  will  then  put  the  matter  of 
accounting  for  the  tax  clearly  up  to  the  debtor  corpora- 
tion, which  must  assume  the  payment  of  the  tax  or 
else  violate  its  bond  covenant. 

Debtor  corporations  or  their  paying  agents,  in  the 
case  of  bonds  not  containing  the  tax-free  clause,  must 
still  require  the  recipients  of  the  interest,  if  they  are 
citizens  or  residents  of  the  United  States,  to  execute 
ownership  certificate  form  1001,  but  such  corporations 
or  agents  will  not  be  required  to  withhold  or  to  list  in- 
dividually such  payments  on  the  monthly  report  form 
1012,  but  simply  show  the  total  number  and  amount  of 
such  certificates  on  the  last  line  of  form  1012  and  for- 
ward the  ownership  certificate  and  form  1012  with  a  let- 
ter of  transmittal  to  the  collector  of  internal  revenue  on 
or  before  the  20th  day  of  the  month  following  that  in 
which  such  payments  were  made.  Of  course,  in  the  case 
of  payment  of  interest  on  such  bonds  to  non-resident 
alien  individuals,  the  tax  should  be  withheld  at  the  rate 
of  2  per  cent  and,  in  the  case  of  non-resident  aliens  cor- 
porations, at  the  rate  of  6  per  cent. 

Withholding  on  dividends  on  the  stock  of  domestic  corpo- 
rations.— Withholding  on  dividends  on  stock  of  domestic 
corporations  applies  only  when  the  income  accrues  to 
non-resident  alien  corporations.  The  withholding  will 
be  at  the  rate  of  2  per  cent,  which  is  the  same  rate  as 
that  which  the  corporation  would  have  to  pay  on  divi- 
dends from  domestic  corporations. 

Situations  arising  in  cases  where  the  record  owner 
is  not  the  actual  owner  are  to  be  handled  in  a  manner 
similar  to  that  of  the  handling  of  situations  arising  in 
cases  in  which  registered  bonds  are  concerned  (p. 
264). 


"WITHHOLDING,"    ETC.,   AT   SOURCE 


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272        INCOME   AND    FEDERAL    TAX    REPORTS 

Treasury  Decision  2452  follows: 

When  a  non-resident  alien  record  owner  of  stock  of  domestic  or  resident 
corporations  is  an  organization  subject  to  withholding  at  the  source  of 
dividend  payments,  as  provided  by  section  13(f)  of  the  act  of  September 
8,  1916,  but  is  not  the  actual  owner  of  the  stock,  such  record  owner  may 
adapt  income  tax  certificate  Form  1087,  to  disclose  actual  ownership  and 
to  claim  exemptions  from  withholding  by  striking  out  the  words  "to  be 
filed  with  representative  in  the  United  States  of  such  Foreign  Principal" 
in  the  caption  and  the  words  "in  the  United  States"  in  the  body  of  the 
form  and  executing  the  certificate  as  the  representative  of  the  actual  owner, 
as  provided  in  the  space  for  signature. 

Thus  modified,  certificates  Form  1087  may  be  filed,  under  the  penalties 
prescribed  for  misrepresentation,  with  debtor  corporations  or  their  with- 
holding agents  in  the  United  States  and  may  be  accepted  by  them  as 
evidence  that  the  record  owner  is  not  liable  for  income  tax  on  the  divi- 
dends to  be  paid  and  hence  is  not  subject  to  having  tax  withheld. 

If  the  record  owner  does  not  exercise  his  right  to  disclose  actual  owner- 
ship for  the  purpose  of  claiming  exemption  from  having  tax  withheld  at 
the  source,  debtor  corporations  and  their  withholding  agents  in  the  United 
States  will  be  held  liable  on  their  stock  records  of  ownership  for  the  tax 
required  to  be  withheld  by  section  13(f)   of  the  act  of  September  8,  1916. 

In  the  absence  of  a  disclosure  of  actual  ownership  filed  with  debtor 
corporations  or  their  withholding  agents  on  certificate  Form  1087,  the 
normal  tax  required  to  be  withheld  in  accordance  with  stock  records  of 
ownership  can  only  be  released  to  a  record  owner  not  liable  for  tax,  upon 
a  proper  showing  to  the  Commissioner  of  Internal  Revenue  of  record  and 
actual  ownership,  the  names  and  post-office  addresses  of  debtor  corpora- 
tions and  withholding  agents,  and  the  amounts  withheld. 

As  a  record  owner  is  held  to  be  "the  proper  representative  having  the 
receipt,  custody,  control  or  disposal"  (Sec.  9(g),  act  of  September  8,  1916) 
of  income  of  the  actual  owner,  this  showing  should  be  made  by  means  of 
a  return  by  or  in  behalf  of  the  actual  owner  when  the  actual  owner  is 
liable  for  a  return  under  the  provisions  of  law. 

When  a  return  is  not  required  to  be  filed  by  or  in  behalf  of  the  actual 
owners,  the  showing  may  be  made  upon  the  certification  of  the  record 
owner. 

Upon  the  showing  thus  made,  either  by  certification  or  return,  as  the 
circumstances  may  require,  the  Commissioner  of  Internal  Revenue  will 
make  such  assessments  and  issue  such  instructions  to  debtors  and  with- 
holding agents  as  will  insure  the  proper  collection  of  tax  in  accordance 
with  the  respective  actual  tax  liabilities. 

The  law  does  not  provide  any  method  for  withholding 
the  tax  on  dividends  paid  in  stock  of  the  corporation. 
The  safest  procedure  for  the  issuing  corporation  to  fol- 
low would  be  to  require  the  foreign  stockholder  to  de~ 


"with holding;'  etc.,  at  source  273 

posit  an  amount  of  money  sufficient  to  cover  the  tax 
required  to  be  withheld,  before  turning  over  the  cer- 
tificates for  the  new  shares. 

Withholding  on  miscellaneous  incomes. — The  withholding 
of  the  tax  on  miscellaneous  income  should  be  at  the 
rates  of  2  per  cent  on  income  accruing  to  non-resident 
alien  individuals  and  6  per  cent  to  non-resident  alien 
corporations. 

This  would  include  any  royalties,  disposition  of  profits 
(other  than  dividends),  interest  on  bank  deposits,  com- 
missions, or  any  other  income  that  was  actually  deter- 
minable. 

It  would  also  include  that  income  paid  by  a  fiduciary 
or  executor  of  an  estate  where  the  beneficiary  was  a 
non-resident  alien. 

Claims  for  deduction  allowed  non-residents. — No  claims 
for  the  specific  exemptions  of  $3,000  or  $4,000  allowed 
under  the  1916  law  will  be  allowed  non-resident  claims, 
as  these  exemptions  have  been  eliminated  in  the 
amended  law.  (Section  7,  subdivision  (b).)  The  non- 
resident alien  may,  however,  file  with  the  withholding 
agent  a  claim  for  the  benefit  of  known  deductions  allow- 
able on  or  before  Feb.  1. 

Refund  to  non-residents  for  excess  taxes  withheld  at  the 
source. — In  cases  of  excess  taxes  withheld  at  the  source 
from  non-resident  aliens  such  non-resident  aliens 
should  file  with  the  collector  of  internal  revenue  at 
Baltimore,  Md.,  on  or  before  March  1,  a  true  and  accu- 
rate return  of  total  income  from  sources  within  the 
United  States  and  attach  to  such  return  a  complete  state- 
ment clearly  setting  forth  the  names  and  addresses  of  the 
withholding  agents,  and  the  districts  wherein  their 
withholding  reports  were  filed,  so  that  proper  adjustment 
may  be  made  in  order  that  correct  assessment  may  be 
made  against  the  withholding  agent,  and  the  difference 
then  refunded  by  such  withholding  agent  to  the  non- 
resident alien.    If  such  report  cannot  be  filed  within 


274 


INCOME   AND   FEDERAL    TAX   REPORTS 


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"WITHHOLDING,"    ETC.,    AT    SOURCE  275 

that  time,  and  the  total  tax  is  withheld  and  paid  by  the 
withholding  agent,  the  non-resident  alien  should  make 
claim  for  refund  on  Form  46,  and  attach  to  such  form 
a  copy  of  his  true  and  actual  return  of  net  income. 

A  State,  county,  municipality  or  any  other  political 
subdivision  of  a  State  is  not  required  to  withhold  any 
amount  of  income  tax  from  interest  which  it  may  pay 
upon  its  own  obligations,  even  though  such  interest  is 
paid  to  non-resident  alien  individuals  or  to  foreign  cor- 
porations. 

Reports  required  of  withholding  corporations. — Debtor 
corporations  withholding  any  amount  of  income  tax 
from  interest  on  "tax-free"  obligations  paid  to  citizens 
or  residents  of  the  United  States,  are  required  to  report 
such  payments,  on  the  prescribed  form  (Form  1012),  to 
the  collectors  for  their  districts  within  twenty  days  after 
the  close  of  the  month  during  which  the  tax  was  with- 
held. This  ruling  is  also  applicable  to  any  payments 
of  interest  made  on  corporate  obligations,  whether 
"tax-free"  or  not,  made  to  non-resident  alien  individuals, 
foreign  corporations,  joint  stock  companies,  etc.,  having 
no  office  or  place  of  business  in  the  United  States. 

A  return  of  the  amount  of  tax  withheld  from  pay- 
ments of  fixed  and  determinable  gains,  profits  or  income 
made  to  non-resident  alien  individuals,  other  than  in- 
terest on  corporate  obligations,  by  individuals,  citizens 
or  residents  of  the  United  States,  domestic  or  resident 
corporations,  joint  stock  companies,  etc.,  is  not  required 
until  after  the  close  of  the  year  during  which  the  tax 
was  withheld,  but  such  returns  are  not  to  be  filed  later 
than  March  1  of  the  next  succeeding  year  on  forms  1042 
and  1098. 

The  amount  of  tax  assessed  against  such  withholding 
returns  as  are  rendered  is  to  be  paid  by  the  withholding 
agent  to  the  collector  of  internal  revenue  for  the  district, 
after  receipt  from  the  collector  of  a  notice  of  the  amount 
assessed  and  demand  therefor. 


276  INCOME   AND   FEDERAL   TAX   REPORTS 

Release  of  tax  heretofore,  but  not  now,  required  to  be  with- 
held.— Section  1212  of  the  act  of  October  3, 1917,  provides 
that  any  amount  heretofore  withheld  by  any  withhold- 
ing agent,  as  required  by  Title  I  of  the  act  of  Septem- 
ber 8,  1916,  on  account  of  the  tax  imposed  upon  the 
income  of  any  individual,  a  citizen  or  resident  of  the 
United  States,  for  the  calendar  year  of  1917,  except 
that  withheld  from  interest  paid  on  bonds  containing  a 
"tax-free"  or  "no-deduction"  clause,  shall  be  released 
and  paid  over  to  such  individual. 

Therefore,  any  amount  of  normal  tax  withheld  during 
the  year  1917  from  income  paid  to  a  citizen  or  resident 
of  the  United  States,  including  income  withheld  on  sal- 
ary paid  to  officers  and  employees  of  a  corporation  or 
firm,  except  interest  on  bonds  and  mortgages  or  deeds 
of  trust,  or  other  similar  obligations  of  corporations, 
joint  stock  companies,  etc.,  containing  a  so-called  "tax- 
free"  or  "no-deduction"  clause,  may  now  be  released 
and  paid  over  to  such  individual,  and  no  return  or  pay- 
ment of  such  tax  will  be  required  from  the  withholding 
agent. 

In  a  case  where  a  bank  or  other  collection  agency 
detached  the  ownership  certificate  which  accompanied 
an  interest  coupon  and  substituted  its  own  certificate, 
Form  1059,  which  did  not  disclose  the  name  and  ad- 
dress of  the  bond  owner,  it  is  held  that  where  substi- 
tute certificate,  Form  1059,  has  been  used  in  connection 
with  coupons  from  bonds  which  do  not  contain  a  "tax- 
free"  or  "no  deduction"  clause,  the  withholding  agent 
shall  request  the  bank  or  collection  agency  to  disclose 
the  name  and  address  of  the  owner  of  the  bond,  as 
shown  by  the  original  certificate,  and  it  shall  be  the 
duty  of  the  bank  or  collection  agency  to  make  such  dis- 
closure to  the  withholding  agent.  If  the  owner  of  the 
bond  is  a  citizen  or  resident  of  the  United  States,  the 
withholding  agent  shall  refund  the  amount  of  tax  de- 
ducted, as  provided  by  law,  and  if  a  non-resident  alien, 


"WITHHOLDING,"    ETC.,    AT    SOURCE  277 

no  refundment  shall  be  made,  but  the  withholding  agent 
shall  make  return  thereof  on  or  before  March  first,  and 
on  or  before  the  time  fixed  by  law  for  the  payment  of 
the  tax  shall  pay  the  amount  withheld  to  the  Auditor 
of  the  United  States  Government  authorized  to  receive 
the  same.     (T.  D.  2635.) 

In  lieu  of  withholding  at  the  source  on  salaries  and 
other  fixed  and  determined  annual  income  paid  to  in- 
dividuals, the  law  now  provides  for  an  elaborate  system 
of  information  at  the  source. 

INFORMATION  AT  THE  SOURCE 

Returns  of  information. — Section  26  of  the  act  of  Sep- 
tember 8, 1916,  as  amended,  provides  that  every  corpora- 
tion, joint-stock  company  or  association  or  insurance 
eompany  subject  to  the  Federal  Income  Tax  on  its  own 
income,  shall,  when  required  by  the  Commissioner  of 
Internal  Revenue,  render  a  correct  return  on  form 
1096,  duly  verified  under  oath,  of  its  payments  of 
dividends,  whether  made  in  cash  or  its  equivalent  or  in 
stock,  which  return  shall  give  the  names  and  addresses 
of  the  stockholders,  the  number  of  shares  owned  by  each, 
the  aggregate  amount  of  dividends  received  by  each,  and 
the  tax  years  and  the  applicable  amounts  in  which  such 
dividends  were  earned.1 

Section  27  provides  that  every  person,  corporation, 
partnership  or  association,  doing  business  as  a  broker 
on  any  exchange  or  board  of  trade  or  other  similar 
place  of  business  shall,  when  required  by  the  Commis- 
sioner of  Internal  Eevenue,  render  a  correct  return 
on  form  1096,  duly  verified  under  oath,  showing  the 
names  and  addresses  of  customers  for  whom  any  busi- 
ness has  been  transacted,  with  such  details  as  to 
profits,  losses  or  other  information  which  the  Commis- 
sioner of  Internal  Revenue  may  require  to  enable  him  to 

i  For  the  present  the  commissioner  will  not  require  this   information. 
(Letter  dated  February  14,  1918.) 


278  INCOME   AND    FEDERAL    TAX   REPORTS 

determine  whether  all  income  tax  due  on  profits  or  gains 
of  such  customers  has  been  paid.1 

Section  28  provides  that  all  persons,  corporations, 
partnerships,  associations  and  insurance  companies, 
making  a  payment  to  any  person,  corporation,  partner- 
ship, association  or  insurance  company,  of  interest, 
rent,  salaries,  wages,  premiums,  or  other  items  of  fixed 
and  determinable  gains,  profits  and  income  (other  than 
dividends  on  stocks  or  gains  or  profits  derived  from 
transactions  on  any  exchange  or  board  of  trade,  or  other 
similar  place  of  business)  of  $800  or  more  during  any 
calendar  year,  shall  render  a  true  and  accurate  return 
on  forms  1096  and  1099  covering  the  payments  made, 
which  return  shall  disclose  the  names  and  addresses  of 
the  recipients  of  such  payments  and  the  aggregate  amount 
paid  to  each  during  the  calendar  year. 

This  report  must  show  the  name  of  the  recipient  of 
the  income,  the  address,  and  the  total  income  paid  dur- 
ing the  year. 

A  return  is  not  required  to  be  filed  where  an  indi- 
vidual is  paid  merely  at  a  rate  equal  to  or  in  excess  of 
$800  a  year,  if  the  entire  amount  actually  paid  to  him 
within  the  year  did  not  equal  or  exceed  $800. 

It  does  not  matter,  for  the  purpose  of  the  tax,  in 
what  form  an  individual  is  paid,  whether  his  income 
is  fixed  or  not,  whether  he  receives  wages  or  is  paid  on 
a  piece-work  basis;  if  his  total  income  from  a  single 
payor  during  the  year  equalled  $800,  such  payor  must 
file  a  return.  A  return  of  information  at  the  source  is 
required,  moreover,  if  the  cash  compensation  paid,  plus 
any  commissions,  living  expenses,  or  other  allowances, 
in  the  aggregate  amount  exceeds  $800  for  the  tax  year. 

This  requirement  also  attaches  to  fiduciaries  paying 
any  beneficiary  to  an  estate  income  of  $800  or  more 
during  the  year  (see  chapter  on  Fiduciaries). 

i  For  the  present  the  commissioner  will  not  require  this  information. 
(Letter  dated  February  14,  1918.) 


"WITHHOLDING,"   ETC.,   AT   SOURCE  279 

Keturns  of  information  will  also  be  required,  regard- 
less of  amounts  paid,  in  the  case  of  payments  of  inter- 
est upon  bonds  and  mortgages  or  deeds  of  trust  or  other 
similar  obligations  of  corporations,  joint-stock  companies, 
associations  and  insurance  companies  and,  also,  in  the 
case  of  collections  of  items  (not  payable  in  the  United 
States)  of  interest  upon  the  bonds  of  foreign  countries 
and  interest  upon  bonds  and  dividends  from  the  stock 
of  foreign  corporations,  from  all  persons,  corporations, 
partnerships  or  associations  which  undertake  as  a  mat- 
ter of  business  or  profit  the  collection  of  foreign  pay- 
ments of  interest  or  dividends  by  means  of  coupons, 
checks  or  bills  of  exchange  on  forms  1096  and  1099. 

Such  certificates  or  forms  are  not  required  to  be  filed 
nor  such  information  given  by  the  paying  bank  regard- 
ing the  payment  of  interest  on  either  the  3y2  per  cent 
or  the  4  per  cent  Liberty  Bonds  when  interest  coupons 
are  presented  for  collection. 

Payment  to  agent. — When  an  agent  receives,  in  behalf 
of  his  principal,  a  payment  falling  within  the  pro- 
vision of  the  law  for  information  at  the  source,  the  agent 
is  required  by  law  to  furnish  the  name  and  address  of 
the  principal  upon  receipt  of  a  demand  therefor  from 
the  payor.  If  the  agent  refuses  to  comply  with  this 
demand  he  becomes  liable  for  a  penalty  of  not  less  than 
$20  nor  more  than  $1,000. 

License  for  collecting  foreign  income. — Under  the  pro- 
visions of  section  9  of  the  act  of  September  8,  1916,  as 
amended,  no  person,  corporation,  partnership  or  associ- 
ation can  undertake  as  a  matter  of  business  or  for 
profit  the  collection  of  foreign  payments  of  interest  or 
dividends  by  means  of  coupons,  checks  or  bills  of  ex- 
change without  first  obtaining  a  license  from  the  Com- 
missioner of  Internal  Revenue,  and  whoever  knowingly 
undertakes  to  collect  such  payments,  as  aforesaid,  with- 
out having  obtained  a  license  therefor,  or  without  com- 
plying with   prescribed   regulations,    shall   be   deemed 


280  INCOME   AND    FEDERAL    TAX   REPORTS 

guilty  of  a  misdemeanor  and  for  each  offense  be  fined 
in  a  sum  not  exceeding  $5,000,  or  imprisoned  for  a  term 
not  exceeding  one  year,  or  both,  in  the  discretion  of  the 
court. 

Those  who  had  obtained  such  a  license  under  the  act 
of  October  3,  1913,  or  under  the  Act  of  September  8, 
1916,  are  not  required  to  take  out  a  new  license,  as  it  is 
held  that  such  licenses  previously  obtained  under  either 
of  those  acts  fully  meet  this  requirement. 

The  time  for  filing  returns  for  information  at  the 
source  has  been  extended  for  1917  reports  until  April 
1,  1918. 


CHAPTER  XII 
FIDUCIARIES 

WHO  ARE  FIDUCIARIES 

"Fiduciaries"  defined. — For  the  purpose  of  the  In- 
come Tax  law,  the  term  "fiduciaries"  includes  "guard- 
ians, trustees,  executors,  administrators,  receivers,  con- 
servators and  all  persons,  corporations,  or  associations, 
acting  in  any  fiduciary  capacity."  A  fiduciary  capacity 
is  that  in  which  a  person  holds  the  legal  title  to  an 
estate  in  which  another  person,  known  as  the  bene- 
ficiary, has  the  beneficial  interest.  The  beneficiary,  as 
well  as  the  fiduciary,  may  be  either  an  individual  or 
a  corporation  or  other  organization.  Where  the  fidu- 
ciary is  a  corporation,  it  is  for  all  intents  and  purposes 
to  regard  itself  as  an  individual  fiduciary,  that  is,  there 
are  no  separate  forms  for  corporate  and  individual  fidu- 
ciaries. 

Classes  of  fiduciaries. — The  following  paragraphs  give 
brief  definitions  of  the  classes  of  fiduciaries,  within 
the  meaning  of  the  term  as  used  in  the  Income  Tax  law. 

Guardian. — A  legal  guardian  (in  whom  is  vested  legal 
title  to  an  estate  for  the  benefit  of  a  minor,  whether  or 
not  he  is  the  parent  of  the  minor  child)  is  a  fiduciary, 
but  a  natural  guardian,  as  such,  is  not.  The  guardian 
of  an  insane  or  otherwise  incompetent  person  comes 
under  the  first  classification. 

Trustee. — A  trustee  is  a  person  who  holds  the  legal 
title  to  an  estate,  and  as  such  has  the  right  to  control  it, 
though  the  beneficial  interest  belongs  to  another  person. 
Trustees  of  individuals  in  bankruptcy  are  fiduciaries; 
those  of  corporations  are  not,  that  is,  the  trustees  or 

281 


282  INCOME    AND    FEDERAL    TAX    REPORTS 

receivers  of  corporations  in  bankruptcy  report  on  the 
forms  used  for  corporations  and  can  know  how  to  fill 
out  their  returns  if  they  look  upon  themselves  as  agents 
for  the  corporation. 

Executor. — An  executor  is  one  who  gets  title  to  the 
personal  estate  of  a  decedent  by  virtue  of  an  appoint- 
ment in  the  latter's  will  and  a  confirmation  of  that  ap- 
pointment by  the  proper  judicial  officer,  such  as  a  sur- 
rogate or  judge  of  a  probate  or  orphans'  court.  After 
an  executor  has  converted  an  estate  into  money,  ascer- 
tained its  exact  amount,  paid  debts  and  specified  legacies 
he  may  continue  to  hold  some  of  the  property  under  a 
direction  contained  in  the  will  as  trustee  for  named 
beneficiaries.  ' 

Administrator. — An  administrator  is  one  who  gets 
title  to  the  personal  estate  of  a  decedent  by  virtue  of 
an  appointment  by  a  court  charged  with  the  administra- 
tion of  the  estate.  Thus  executors  are  appointed  in  a 
will  and  administrators  are  appointed  where  there  is 
no  will,  or  where  the  will  makes  no  nomination  or  where 
the  person  named  in  the  will  fails  to  qualify. 

Receiver. — A  receiver  is  an  impartial  person  ap- 
pointed by  a  court  of  equity  to  hold  property,  pending 
the  termination  of  litigation  with  respect  to  the  prop- 
erty. The  receiver  is  "the  right  arm  of  the  court"  and 
his  holding  of  the  property  in  effect  puts  the  control  of 
the  property  in  the  hands  of  the  court  itself.  The  re- 
ceiver for  an  individual  is  classed  as  a  fiduciary — but 
the  receiver  for  a  corporation,  joint-stock  company,  as- 
sociation or  insurance  company  is  not.  The  receivers 
for  such  organizations  report  their  income  on  the  cor- 
porate forms. 

Conservator. — Conservators  are  persons  designated 
by  law  to  hold  property  pending  its  ultimate  disposition 
by  virtue  of  some  provision  of  the  law.  They  are 
ordinarily  charged  with  no  active  duties  respecting 
the  estate  beyond  doing  what  is  necessary  to  conserve  it. 


FIDUCIARIES  283 

Agent  not  a  fiduciary. — Since  a  fiduciary  must  be  one 
who  holds  legal  title  for  the  benefit  of  a  cestui  que 
trust,  an  agent  acting  only  under  a  power  of  attorney 
is  not  a  fiduciary,  within  the  meaning  of  the  Income 
Tax  law,  whatever  may  be  his  authority  as  to  manage- 
ment and  distribution  of  the  estate  or  income  of  his 
principal. 

Receivers,  trustees  in  bankruptcy  and  assignees  of  cor- 
porations etc.,  are  not  fiduciaries. — A  receiver,  trustee  in 
bankruptcy,  or  assignee  of  a  corporation,  joint-stock 
company  or  association  or  insurance  company,  as  we 
have  seen,  is  not  a  fiduciary,  but  an  agent,  and  is  re- 
quired to  render  regular  returns  of  corporate  income 
in  the  same  manner  and  form  as  would  the  officers  of 
the  corporation  were  they  themselves  operating  its 
business. 

Receivers,  etc.,  for  individuals  are  fiduciaries. — The  fore- 
going paragraph  applies  only  to  corporations  and  other 
organizations  as  specified  therein,  and  not  to  individ- 
uals. Eeceivers,  trustees  and  assignees  of  individuals 
are  fiduciaries,  for  the  purpose  of  the  tax. 

Who  are  beneficiaries. — Any  person  entitled  to  an  in- 
terest in  the  estate  held  by  a  fiduciary  is  said  to  be  a 
beneficiary.  Thus  legatees,  heirs,  wards,  creditors  of 
bankrupt  individuals  are  all  looked  upon  as  beneficiaries 
and  even  the  estate  itself  is  to  be  regarded  a  beneficiary 
in  respect  to  income  received  during  the  year  and  un- 
distributed. 

WHAT  REPORTS  MUST  BE  FILED  BY  FIDUCIARIES 

Fiduciaries  act  for  and  are  subject  to  provisions  apply- 
ing to  individuals. — In  general,  fiduciaries  are  required 
to  "make  and  render  a  return  of  the  income  of  the 
person,  trust,  or  estate  for  whom  or  which  they  act, 
and  be  subject  to  all  the  provisions  of  this  title  which 
apply  to  individuals."  They  must  file  (1)  reports  of 
information  at  the  source  and  (2)  reports  of  taxable 


284  INCOME    AND    FEDERAL    TAX    REPORTS 

income   on  Forms  1040  or   1041,   as   explained   in  the 
following  sections. 

Report  of  information  at  the  source. — If  the  income 
paid  by  a  fiduciary  to  a  beneficiary  amounts  during  a 
calendar  year  to  $800  or  more,  he  must  file  a  return  of 
information  at  the  source  at  such  time  and  in  such 
manner  as  may  be  prescribed  by  the  Commissioner  of 
Internal  Eevenue,  with  the  approval  of  the  Secretary 
of  the  Treasury. 

This  report  is  not  a  report  of  income  received  by  the 
fiduciary,  but  a  report  of  money  paid  over  to  the  bene- 
ficiary and  is  a  counterpart  of  the  report  required  of 
any  person  who  pays  money  in  excess  of  or  equal  to 
$800  to  another  when  the  money  paid  is  considered  in- 
come by  the  latter.  See  preceding  chapter  on  "With- 
holding," etc.,  at  the  Source." 

No  report  required  if  only  corpus  of  estate  is  distributed. 
— Income  paid  to  beneficiaries  must  be  reported  under 
the  conditions  mentioned  above,  but  if  the  amounts  paid 
to  the  beneficiary  are  a  distribution  of  only  the  prin- 
cipal or  corpus  of  the  estate,  no  report  is  required. 

Report  when  income  from  estate  is  distributed  annually. 
— In  the  case  of  estates  the  income  of  which  is  distrib- 
uted annually,  if  the  amount  paid  during  the  calendar 
year  to  any  one  beneficiary  is  in  excess  of  the  specific 
exemption  allowed  to  that  beneficiary,  $1,000  or  $2,000 
as  the  case  may  be,  the  fiduciary  is  required  to  file  a 
return  on  Form  1041,  that  is,  if  there  is  among  the 
beneficiaries  one  or  more  receiving  an  amount  in  excess 
of  the  specific  exemption,  so  that  the  income  tax  would 
apply,  the  return  must  be  filed  on  Form  1041,  and  on 
this  return  must  be  shown  not  only  the  amounts  paid  to 
the  taxable  beneficiary,  but  also  all  amounts  paid  to  all 
other  beneficiaries. 

Fiduciary  to  pay  tax  on  income  of  decedent  earned  prior 
to  his  death. — If  the  net  income  of  a  decedent  from  Jan- 
uary 1,  of  the  year  during  which  he  died  to  the  date 


FIDUCIARIES  285 

of  his  death  equalled  or  exceeded,  in  the  case  of  an 
unmarried  person,  $1,000,  and  in  the  case  of  a  married 
person,  $2,000,  the  fiduciary  should  file  a  return  on 
Form  1040  on  behalf  of  such  decedent,  and  pay  the  tax 
indicated  to  be  due  by  such  return,  and  if  the  income  of 
the  decedent's  estate  for  the  remainder  of  the  calendar 
year  equals  or  exceeds  $1,000  and  the  estate  is  not 
settled  and  distributed  by  December  31st  of  that  year, 
the  fiduciary  will  be  required  to  file  a  return  (Form 
1040)  on  behalf  of  the  estate,  and  pay  the  taxes  indi- 
cated thereon  to  be  due. 

Taxes  to  be  paid  by  fiduciary  on  income  of  minors,  in- 
sane persons  and  non-resident  alien  beneficiaries. — The  fidu- 
ciary, as  we  have  seen,  is  required  by  law  to  make  out 
the  returns  for  minors,  insane  persons  and  non-resident 
alien  beneficiaries  for  whom  he  acts.  The  law  also  re- 
quires the  fiduciary  in  such  cases  to  pay  the  taxes,  both 
normal  and  additional.  An  exception  exists  in  the  case 
where  a  minor  becomes  of  age  during  the  calendar  year 
for  which  the  income  is  being  reported.  In  such  cases 
the  fiduciary  makes  a  report  for  the  period  during  which 
he  acted,  and  the  minor  also  makes  a  report  which  in- 
cludes also  the  income  received  through  the  fiduciary. 

Report  of  income  of  trust  estate. — Whenever  the  income 
of  a  trust  estate  (that  is,  an  estate  which  receives  its 
own  income,  as  when  the  income,  instead  of  being  dis- 
tributed to  beneficiaries,  is  held  in  trust  or  put  back  or 
added  to  the  corpus  of  the  estate)  equals  or  exceeds 
$1,000,  (the  specific  exemption  allowed  to  estates)  the 
fiduciary  must  file  a  return  of  income  on  Form  1040, 
and  pay  all  the  taxes  and  supertaxes  due  thereon. 

In  cases  where  part  of  the  income  is  retained  by  the 
estate  and  the  balance  distributed  to  beneficiaries,  the 
return  is  not  required  unless  (1)  the  amount  paid  to  a 
beneficiary  or  (2)  the  amount  retained  by  the  estate, 
equals  or  exceeds  the  specific  exemption  allowed  respec- 
tively to  the  beneficiary  or  to  the  estate.    If  the  amount 


286  INCOME    AND    FEDERAL    TAX    REPORTS 

paid  to  any  beneficiary  equals  or  exceeds  the  specific 
exemption  allowed  him  ($1,000  or  $2,000  depending 
upon  his  status)  the  fiduciary  must  file  a  return  on 
Form  1041,  showing  (1)  the  amounts  paid  to  the  bene- 
ficiary; (2)  amounts  paid  to  any  other  beneficiaries  who 
may  have  received  any  sums  whatsoever;  (3)  the 
amounts  retained  by  the  estate.  If  the  income  retained 
by  the  estate  equals  or  exceeds  $1,000,  the  fiduciary 
must  file  also  a  return  on  Form  1040,  for  the  estate 
itself;  that  is,  both  returns  are  required  when  both  the 
estate  and  any  one  or  more  of  the  beneficiaries  are 
taxable. 

Report  of  income  of  estate  during  period  of  settlement. 
— In  the  case  of  estates  during  period  of  administration 
or  settlement,  Form  1040  should  be  filed,  and  normal 
and  supertaxes  paid,  if  the  net  income  during  the  calen- 
dar year  equals  or  exceeds  $1,000;  the  income,  after  the 
tax  has  been  paid  by  the  fiduciary,  becomes  part  of  the 
corpus  of  the  estate,  and  when  such  income  is  later  paid 
over  to  the  beneficiaries  of  the  estate  it  will  be  free  from 
taxation  in  their  hands. 

If,  however,  the  beneficiary  knows  what  share  he  is 
entitled  to,  and  reports  such  income  himself,  the  fidu- 
ciary need  not  report  it  on  Form  1040  but  should  report 
it  on  Form  1041.  In  such  cases  the  estate  is  not  taxed, 
but  the  amount  of  tax  is  based  upon  the  individual's 
income,  and  when  the  income  is  later  transferred  to  the 
beneficiary  it  is  tax-exempt  since  it  has  already  borne 
its  share  of  the  tax. 

Beneficiaries  not  entitled  to  inspect  fiduciary's  return. — 
The  beneficiaries  of  an  estate  are  not  entitled  to  the 
privilege  of  inspecting  the  returns  filed  by  a  fiduciary 
covering  the  estate  in  which  they  are  interested,  since 
the  fiduciary  is  not  subject  to  the  control  of  the  bene- 
ficiaries. 

Fiduciary  should  render  statement  giving  essential  infor- 
mation to  beneficiary. — However,  a  fiduciary  distributing 


FIDUCIARIES  287 

annually  income  of  an  estate  to  a  beneficiary  should 
render  to  such  beneficiary  a  statement  apprising  the 
beneficiary  of  the  sources  of  the  income  so  distributed, 
disclosing  just  what  part  of  the  amount  distributed 
was  received  from  dividends  on  stock  of  corporations 
which  had  already  borne  the  income  tax,  what  amount 
represents  income  already  tax-paid  at  the  source,  and 
what  income  was  not  tax-paid  at  the  source,  in  order 
that  the  beneficiary  may  be  in  a  position  properly  to 
account  for  such  income  under  the  proper  captions  in 
his  own  personal  return  of  income,  on  Form  1040. 

If  any  part  of  the  income  distributed  to  the  bene- 
ficiary is  tax-exempt,  such  as  income  from  public  secur- 
ities, property  coming  to  the  estate  by  gift,  bequest,  de- 
vise or  descent,  or  if  any  portion  of  the  corpus  of  the 
estate  is  distributed  to  the  beneficiary,  he  should  be  in- 
formed of  the  fact  by  the  fiduciary,  in  order  that  the 
beneficiary  may  omit  such  items  from  his  tax  return. 

Report  of  income  of  decedent  prior  to  his  death. — If,  dur- 
ing the  year  of  a  decedent's  death,  and  prior  to  that 
event,  his  net  income  equalled  or  exceeded  the  exemp- 
tions allowed  ($1,000  or  $2,000,  as  the  case  might  have 
been)  the  fiduciary  must  file  a  personal  return  on  Form 
1040,  executed  for  and  in  behalf  of  the  decedent  as  his 
agent;  he  must  file  also  another  return  upon  the  same 
form  (1040)  for  and  in  behalf  of  the  estate,  if  it  remains 
in  process  of  administration  and  its  net  income  from 
the  date  of  the  decedent's  death  until  the  end  of  the  tax- 
able year  (December  31)  equals  or  exceeds  $1,000. 

Reports  of  ancillary  administrators. — An  ancillary  ad- 
ministrator is  held  to  be  merely  the  agent  of  the  domi- 
ciliary administrator,  and  should  transmit  to  his  prin- 
cipal all  information  as  to  income  received  by  him  as 
such  agent,  in  order  that  the  domiciliary  administrator 
may  make  a  report  covering  the  entire  income  of  the 
estate. 

Reports  for  foreign  beneficiaries. — When  there  is  only 
one  beneficiary  and  he  is  a  non-resident  alien,  the  fidu- 


288  INCOME    AND    FEDERAL    TAX    REPORTS 

ciary  practically  takes  the  place  of  the  beneficiary  and 
makes  out  the  return  for  him  on  Form  1040.  The 
fiduciary  executes  the  report  as  the  agent  of  the  alien 
and  reports  the  income  of  the  estate  as  the  income  of 
the  alien.  Where  there  are  two  or  more  beneficiaries 
the  fiduciary  must  file  one  return  for  the  estate  (Form 
1041)  and  a  separate  return  for  each  non-resident  alien 
beneficiary  (Form  1040).  The  fiduciary  is  required  to 
account  for  and  pay  both  the  normal  taxes  and  super- 
taxes shown  thereon  to  be  due. 

Reports  for  minors  and  insane  persons. — The  fiduciary 
who  acts  for  a  single  minor  or  insane  beneficiary  makes 
out  a  return  for  such  minor  or  beneficiary  on  the  form 
provided  for  individuals;  he  is  not  required  to  make 
out  a  return  as  fiduciary  for  the  estate.  Where,  how- 
ever, the  fiduciary  under  one  estate  has  more  than  one 
ward,  he  should  file  the  fiduciary  return  on  Form  1041, 
and  a  separate  return  on  Form  1040  for  each  ward,  if 
unmarried,  whose  income  is  at  least  $1,000,  and  if  mar- 
ried, is  at  least  $2,000.  Fiduciaries  are  treated  as  the 
agents  of  wards  and  insane  persons  and  are  required 
to  pay  for  their  wards  both  normal  and  additional  taxes 
out  of  the  income  in  their  control.  The  fiduciary,  in  fil- 
ing returns  for  wards  or  other  beneficiaries,  should 
claim  for  and  in  behalf  of  the  ward  or  beneficiary  the 
specific  exemptions  to  which  the  ward  or  beneficiary  is 
entitled. 

When  a  minor  becomes  of  age,  the  fiduciary  is  re- 
quired to  render  a  return  on  Form  1041  stating  such 
facts  and  showing  the  income  for  the  period  from  the 
beginning  of  the  year  to  the  day  when  the  minor  be- 
comes of  age,  and  the  quondam  minor  makes  his  sep- 
arate return  and  includes  all  money  received  by  him 
during  the  year  from  the  guardian. 

Reports  where  there  are  several  trustees. — Where  there 
is  more  than  one  trustee,  one  only  need  file  the  report. 
This  is  usually  done  by  the  person  having  direct  charge 
of  the  estate.    The  fiduciary  executing  the  report  must 


FIDUCIARIES  289 

make  oath  that  he  has  sufficient  knowledge  of  the  affairs 
of  such  person,  trust,  or  estate  to  enable  him  to  make 
the  return. 

WHERE  AND   WHEN  TO   FILE  RETURN 

Where  report  is  filed. — The  fiduciary,  or  the  one  of 
several  fiduciaries,  executing  a  return  should  file  the 
return  in  the  collection  district  where  he  resides  or  has 
his  place  of  business.  The  residence  of  the  beneficiaries 
is  immaterial  in  determining  this  question. 

When  returns  must  be  filed. — All  returns  required  of 
fiduciaries  must  be  filed  on  or  before  March  1,  1918,  un- 
less an  extension  of  30  days  time  is  granted  by  the  col- 
lector of  internal  revenue.  Corporate  trustees  are  gov- 
erned by  the  same  rules  as  apply  to  individuals  and 
must  report  for  the  calendar  year.  Failure  to  file  a 
return  within  the  time  prescribed  subjects  the  fiduciary 
to  the  same  penalties  as  are  imposed  upon  an  individual, 
excepting  the  penalty  of  the  50  per  cent  additional  to 
the  tax. 

The  tax  is  due  and  payable  on  or  before  June  15,  and 
for  failure  to  remit  the  tax  within  that  time  or  within 
10  days  after  notice  and  demand  (Form  17)  a  5  per  cent 
penalty  will  be  added,  together  with  interest  at  the  rate 
of  1  per  cent  per  month. 

CONTENTS  OF    REPORTS  OF  FIDUCIARY 

Gross  income. — Gross  income  consists  of  the  income 
received  by  a  fiduciary  for  the  benefit  of  the  estate.  It 
will  be  remembered  of  course  that  the  report  is  really 
being  made  by  the  fiduciary  for  the  estate  and  every- 
thing included  in  the  report  for  any  estate  is  treated 
as  though  it  were  the  sole  income  or  outgo  of  the  fidu- 
ciary as  a  fiduciary.  In  other  words,  the  fiduciary 
should  not  confuse  with  the  estate  he  is  reporting,  any 
income  from  transactions  that  pertain  only  to  his  own 
personal  business  or  to  that  of  other  estates  he  may 


290  INCOME    AND    FEDERAL    TAX    REPORTS 

represent.  Where  one  person  creates  several  separate 
estates  with  a  single  trustee,  the  trustee  must  make  out 
separate  returns  for  each  of  the  several  estates,  even  if 
the  beneficiaries  of  the  several  estates  are  the  same  per- 
sons. 

The  gross  income  of  an  estate  to  be  reported  by  fidu- 
ciaries is  similar  to  that  required  to  be  reported  by  an 
individual,  and  will  include  all  income  derived  from 
business,  trade  or  sales;  dealings  in  property,  whether 
real  or  personal,  which  the  estate  may  control  or  be 
interested  in;  rents  received;  and  all  interest  received, 
whether  from  notes,  mortgages  or  bank  balances,  and 
all  interest  from  corporate  obligations  of  domestic  cor- 
porations. Interest  received  on  obligations  of  foreign 
corporations  should  be  separately  reported,  together 
with  dividends  on  stock  paid  by  foreign  corporations 
having  no  place  of  business  in  the  United  States. 

Distributive  net  interest  in  partnerships  in  which  the 
estate  may  share  should  be  reported  under  a  separate 
caption,  and  income  from  royalties  or  any  other  miscel- 
laneous income  received  should  also  be  separately  re- 
ported. 

,  All  dividends  received  by  the  estate  from  domestic 
corporations,  or  which  have  been  received  through  other 
estates  or  through  a  partnership  distribution  of  divi- 
dends on  stock  of  domestic  corporations  held  by  the 
partnership  should  be  grouped  and  shown  separately, 
for  the  reason  that  such  income  has  already  borne  its 
tax  burden. 

Interest  on  bonds  or  obligations  of  the  United  States 
(issued  prior  to  September  1,  1917),  or  any  of  its  pos- 
sessions or  of  any  State  or  political  subdivision  of  a 
State,  need  not  be  reported. 

Interest  on  Liberty  S^'s  need  not  be  reported,  but 
interest  on  a  total  in  excess  of  $5,000  par  value  of 
Liberty  4's,  Treasury  Certificates  of  Indebtedness  and 
War  Saving  Certificates,  must  for  the  purpose  of  the 


FIDUCIARIES  291 

income  tax  be  shown  in  the  report  when  such  a  report 
is  required  to  be  filed. 

Property  received  by  the  estate  by  way  of  gift,  be- 
quest or  devise  need  not  be  reported,  but  income  earned 
from  such  property  must  be  reported. 

Deductions  from  gross  income  in  report  filed  by  fiduciary. 
— Certain  expenses  may  be  incurred  in  the  earning  of 
income  by  an  estate.  These  are  allowable  deductions 
from  gross  income,  as  are  similar  expenses  incurred  by 
individuals  in  the  earning  of  their  incomes.  These  ex- 
penses include  such  business  expenses  as  wages,  salaries, 
repairs  and  rentals. 

Amounts  paid  for  permanent  improvements  or  better- 
ments are  capital  expenses,  and  are  not  deductible. 

Expenses  of  the  administration  of  an  estate,  such 
as  court  costs,  attorneys'  fees,  etc.,  are  chargeable 
against  the  corpus  of  the  estate  before  distribution  to 
the  beneficiaries,  and  therefore  reduce  the  estate  while 
it  is  still  in  the  administrators'  hands,  hence  they  are 
not  deductible  from  gross  income  in  the  income  tax  re- 
port. 

With  regard  to  executors'  and  administrators'  com- 
missions, it  should  be  definitely  ascertained  by  a  fidu- 
ciary whether  under  State  laws,  under  the  terms  of  a 
will,  or  by  the  decree  of  a  court,  the  commissions  in 
question  are  deductible  from  the  corpus  of  the  estate, 
or  from  the  income  accruing  to  the  beneficiaries  of  the 
estate.  If  the  commissions  are  properly  deductible 
from  the  corpus  of  the  estate,  they  should  not  be  de- 
ducted from  gross  income  in  the  fiduciary's  report.  If, 
on  the  other  hand,  the  commissions  are  to  be  deducted 
from  the  income  of  the  estate  distributable  among  the 
beneficiaries,  the  amount  should  be  charged  as  a  legiti- 
mate and  necessary  expense,  properly  deductible  from 
the  gross  income  of  the  estate. 

Besides  necessary  expenses,  there  may  be  deducted 
from  gross  income  all  interest  paid  within  the  year, 


292  INCOME   AND    FEDERAL    TAX   REPORTS 

except  on  indebtedness  incurred  in  purchasing  securities 
which  are  also  deductible,  excepting  state  inheritance 
and  Federal  Estate  taxes,  these  being  properly  charge- 
able against  the  corpus  of  the  estate. 

Losses  sustained  during  the  year  are  allowable  de- 
ductions if  similar  losses  sustained  by  an  individual 
would  be  deductible.  (See  Chapter  on  Individual  In- 
come Tax,  Deductions.) 

Debts  past  due  and  actually  ascertained  to  be  worth- 
less and  which  did  not  become  due  until  after  the  dece- 
dent's death,  may  be  charged  off  if  the  amounts  which 
they  represent  were  included  as  income  in  a  previous 
year's  return  of  the  fiduciary. 

Debts  due  the  decedent  cannot  be  charged  off  under 
this  caption,  for  the  reason  that  those  bad  debts  reduce 
the  corpus  of  the  estate.  The  only  allowable  bad  debts 
deductible  are  those  which  the  fiduciary  included  as  in- 
come in  the  present  or  previous  years.  Such  bad  debts 
would  be  those  which  became  due  after  the  death  of 
the  decedent  and  which  represent  amounts  which  have 
been  included  by  the  fiduciary  as  income  in  previous  or 
the  current  year's  income  tax  returns;  or  debts  which 
are  represented  by  investments  or  loans  made  by  the 
fiduciary  after  the  creation  of  the  estate  or  trust. 

A  reasonable  amount  for  depreciation  and  depletion 
is  allowable  as  a  deduction  from  gross  income.  (See 
the  discussion  under  Corporation  Income  Tax,  Deduc- 
tions, pp.  221-243.) 

In  the  case  of  an  estate  the  income  of  which  is  dis- 
tributable annually  to  the  beneficiaries  or,  in  the  case 
of  a  "trust"  estate,  where  the  terms  of  the  will  or  trust 
or  the  decree  of  a  court  of  competent  jurisdiction  pro- 
vide for  keeping  the  corpus  of  the  estate  intact,  and 
when  physical  property  forming  a  part  of  the  corpus 
of  the  estate  has  suffered  depreciation  through  its  use 
or  employment  in  business,  a  reasonable  allowance 
for  depreciation  will  be  permitted,  provided  that  a  de- 


FIDUCIARIES  293 

preciation  reserve  representing  the  amount  of  such  a 
deduction  is  set  aside  out  of  profits  earned  by  the  estate 
since  the  creation  of  the  estate.  Such  depreciation  al- 
lowance will  not  be  deductible  if  no  depreciation  reserve 
is  provided  for  out  of  profits,  and  the  entire  income  is 
being  paid  annually  to  the  beneficiaries. 

Where  fiduciaries  include  as  a  deduction  an  amount 
for  depreciation,  they  should  file  with  their  return  either 
(1)  a  copy  of  the  provisions  of  the  will,  trust  or  decree 
requiring  such  depreciation  deduction  where  any  such 
provisions  exist,  or  (2)  a  statement  showing  that  actual 
depreciation  occurs,  that  the  amount  thereof  is  that 
stated  and  that  the  funds  or  assets  retained  as  a  reserve 
against  depreciation  have  been  or  will  be  preserved  and 
applied  as  such,  and  not  distributed  to  beneficiaries. 

The  purpose  of  these  requirements  is  to  prevent  fidu- 
ciaries from  including  depreciation  deductions  in  the 
returns  they  file  for  the  estate  when,  actually,  there  is 
no  depreciation  reserve  maintained,  but  the  amounts 
claimed  as  a  depreciation  are  in  fact  distributed  to  the 
beneficiaries. 

WHO   PAYS  THE  TAX 

Withholding  at  the  source  against  and  by  fiduciaries. — 
In  respect  to  income  due  fiduciaries,  income  is  treated 
the  same  as  that  due  individuals.  Fiduciaries  who 
are  citizens  or  who  reside  or  have  a  place  of  residence 
here  get  their  income  for  their  estates  without  deduc- 
tion at  the  source.  Foreign  non-resident  fiduciaries  must 
submit  to  the  deduction  of  the  income  at  the  source  and 
persons  paying  such  income  to  them  are  liable  for  the 
tax  in  the  same  way  as  they  are  liable  for  the  taxes  on 
incomes  due  non-resident  alien  individuals. 

The  same  rule  applies  to  the  income  due  from  a 
fiduciary  to  a  beneficiary.  The  former  is  not  bound  to 
make  any  deduction  for  the  tax  except  in  the  case  of 
non-resident  alien  individual  beneficiaries. 


294  INCOME    AND    FEDERAL    TAX    REPORTS 

When  the  beneficiary  reports  and  pays  the  tax. — Where 
the  beneficiary  is  neither  a  minor,  nor  an  insane  per- 
son nor  a  non-resident  alien,  he  makes  his  own  report 
and  includes  in  it  the  income  received  from  the  fiduciary 
or  credited  to  him  by  the  fiduciary.  In  such  case,  of 
course,  the  beneficiary  pays  the  tax  himself. 

When  the  fiduciary  pays  the  tax. — The  fiduciary,  as  we 
have  seen,  pays  the  tax  and  makes  the  return  where  his 
beneficiary  is  a  minor  or  an  insane  person.  He  also 
pays  the  tax,  normal  and  super,  and  makes  a  separate 
return  for  the  income  coming  to  the  estate  that  is  not 
credited  to  any  definite  beneficiary  or  that  is  accumu- 
lated in  trust  for  the  benefit  of  unborn  or  unascertained 
persons,  or  persons  with  contingent  interests.  Where 
income  is  accumulated  for  future  distribution  and  is 
not  credited  to  any  beneficiary  and  is  not  reported  by 
the  beneficiary,  it  is  to  be  treated  as  income  coming 
into  the  hands  of  the  fiduciary,  to  be  reported  by  him. 
The  taxes,  normal  and  additional,  are  in  such  cases  paid 
by  the  fiduciary,  and  the  remaining  income  in  such  cases 
is  looked  upon  thereafter  as  a  part  of  the  corpus  of  the 
estate  not  subject  to  taxation  as  income  when  it  is  trans- 
ferred subsequently  to  the  beneficiary. 

Fiduciary  to  pay  tax  during  period  of  settlement  of  the 
estate. — Taxes,  normal  and  additional,  are  paid  by  the 
fiduciary  on  behalf  of  the  estate  on  income  received  by 
estates  of  deceased  persons,  during  the  period  of  ad- 
ministration or  settlement  of  the  estate.  But  where  the 
income  is  to  be  distributed  annually  or  regularly  and 
where  the  share  of  a  beneficiary  can  be  determined  and 
is  credited  to  such  beneficiary,  if  the  beneficiary  keeps 
his  books  on  an  accrual  basis  he  may  report  the  in- 
come and  pay  the  tax  on  his  share  in  the  same  manner 
as  though  he  had  actually  received  it.  Thus,  if  a  legacy 
of  $100,000  in  bonds  is  left  to  A  and  the  estate  is  quite 
certainly  solvent,  A  may  report  the  interest  accruing 
on  the  bonds  though  the  interest  may  be  collected  and 


FIDUCIARIES  295 

retained  by  the  fiduciary  and  credited  to  the  account  of 
A.  In  such  a  case  A  would  add  the  credited  income  to 
his  own  income  and  pay  the  normal  taxes  as  well  as  the 
additional  taxes  which  such  an  aggregate  income  would 
require. 

A,  of  course,  would  follow  this  procedure  where  his 
aggregate  net  income  is  less  than  the  aggregate  income 
of  the  estate,  since  under  such  circumstances  the  tax  rate 
would  be  lower  on  the  income  if  credited  to  A  and  re- 
ported by  him  than  if  kept  in  the  estate  and  reported 
by  it. 

"Income  of  estate  or  any  kind  of  property  held  in 
trust,  including  such  income  accumulated  in  trust  for 
the  benefit  of  unborn  or  unascertained  persons,  or  per- 
sons with  contingent  interests  and  income  held  for  fu- 
ture distribution  under  the  terms  of  the  will  or  trust" 
will  be  taxed  as  though  it  were  the  income  of  an  in- 
dividual and  paid  by  the  fiduciary.  But  where  the  in- 
come is  to  be  distributed  annually  or  regularly  the 
amount  of  the  tax  is  fixed  with  reference  to  each  bene- 
ficiary's share,  and  paid  by  the  beneficiary. 


CHAPTER  XIII 

THE  INCOME  TAX  LAW,   AFFECT- 
ING INDIVIDUALS  AND 
CORPORATIONS 

TITLE  I  OF  THE  ACT  OF  SEPTEMBER  8,  1916  (39  STATS. 

AT  LARGE  771);  AS  AMENDED  BY  THE  ACT  OF 

MARCH  3, 1917  (39  STATS.  AT  LARGE  1000),  AND 

AS  FURTHER  AMENDED  BY  TITLE  XII 

OF    THE   ACT   OF  OCTOBER  3,   1917 

(PUBLIC— No.  50— 65th  CONGRESS) 


TITLE   I.— INCOME    TAX 

PART  I.— ON  INDIVIDUALS 

Individual  normal  tax  rate. — Sec.  1.  (a)  That  there  shall 
be  levied,  assessed,  collected,  and  paid  annually  upon  the 
entire  net  income  received  in  the  preceding  calendar  year 
from  all  sources  by  every  individual,  a  citizen  or  resi- 
dent of  the  United  States,  a  tax  of  two  per  centum  upon 
such  income ;  and  a  like  tax  shall  be  levied,  assessed,  col- 
lected, and  paid  annually  upon  the  entire  net  income  re- 
ceived in  the  preceding  calendar  year  from  all  sources 
within  the  United  States  by  every  individual,  a  non-resi- 
dent alien,  including  interest  on  bonds,  notes,  or  other 
interest-bearing  obligations  of  residents,  corporate  or 
otherwise. 

Individual  additional  tax  rate. — (b)  In  addition  to  the 
income  tax  imposed  by  subdivision  (a)  of  this  section 
(herein  referred  to  as  the  normal  tax)  there  shall  be 

296 


THE    INCOME    TAX    LAW  297 

levied,  assessed,  collected,  and  paid  upon  the  total  net 
income  of  every  individual,  or,  in  the  case  of  a  non-resi- 
dent alien,  the  total  net  income  received  from  all  sources 
within  the  United  States,  an  additional  income  tax  (here- 
in referred  to  as  the  additional  tax)  of  one  per  centum 
per  annum  upon  the  amount  by  which  such  total  net  in- 
come exceeds  $20,000  and  does  not  exceed  $40,000,  two 
per  centum  per  annum  upon  the  amount  by  which  such 
total  net  income  exceeds  $40,000  and  does  not  exceed 
$60,000,  three  per  centum  per  annum  upon  the  amount 
by  which  such  total  net  income  exceeds  $60,000  and  does 
not  exceed  $80,000,  four  per  centum  per  annum  upon  the 
amount  by  which  such  total  net  income  exceeds  $80,000 
and  does  not  exceed  $100,000,  five  per  centum  per  annum 
upon  the  amount  by  which  such  total  net  income  exceeds 
$100,000  and  does  not  exceed  $150,000,  six  per  centum  per 
annum  upon  the  amount  by  which  such  total  net  income 
exceeds  $150,000  and  does  not  exceed  $200,000,  seven  per 
centum  per  annum  upon  the  amount  by  which  such  total 
net  income  exceeds  $200,000  and  does  not  exceed  $250,000, 
eight  per  centum  per  annum  upon  the  amount  by  which 
such  total  net  income  exceeds  $250,000  and  does  not  ex- 
ceed $300,000,  nine  per  centum  per  annum  upon  the 
amount  by  which  such  total  net  income  exceeds  $300,000 
and  does  not  exceed  $500,000,  ten  per  centum  per  an- 
num upon  the  amount  by  which  such  total  net  income 
exceeds  $500,000  and  does  not  exceed  $1,000,000,  eleven 
per  centum  per  annum  upon  the  amount  by  which  such 
total  net  income  exceeds  $1,000,000  and  does  not  exceed 
$1,500,000,  twelve  per  centum  per  annum  upon  the  amount 
by  which  such  total  net  income  exceeds  $1,500,000  and 
does  not  exceed  $2,000,000,  and  thirteen  per  centum  per 
annum  upon  the  amount  by  which  such  total  net  income 
exceeds  $2,000,000. 

For  the  purpose  of  the  additional  tax  there  shall  be 
included  as  income  the  income  derived  from  dividends  on 
the  capital  stock  or  from  the  net  earnings  of  any  cor- 


298  INCOME    AND    FEDERAL    TAX    REPORTS 

poration,  joint-stock  company  or  association,  or  insur- 
ance company,  except  that  in  the  case  of  non-resident 
aliens  such  income  derived  from  sources  without  the 
United  States  shall  not  be  included. 

All  the  provisions  of  this  title  relating  to  the  normal 
tax  on  individuals,  so  far  as  they  are  applicable  and  are 
not  inconsistent  with  this  subdivision  and  section  three, 
shall  apply  to  the  imposition,  levy,  assessment,  and  col- 
lection of  the  additional  tax  imposed  under  this  sub- 
division. 

(c)  The  foregoing  normal  and  additional  tax  rates 
shall  apply  to  the  entire  net  income,  except  as  hereinafter 
provided,  received  by  every  taxable  person  in  the  calen- 
dar year  nineteen  hundred  and  sixteen  and  in  each  calen- 
dar year  thereafter. 

Individual  income  denned. — Sec.  2.  (a)  That,  subject 
only  to  such  exemptions  and  deductions  as  are  herein- 
after allowed,  the  net  income  of  a  taxable  person  shall 
include  gains,  profits,  and  income  derived  from  salaries, 
wages,  or  compensation  for  personal  service  of  whatever 
kind  and  in  whatever  form  paid,  or  from  professions, 
vocations,  business,  trade,  commerce,  or  sales,  or  deal- 
ings in  property,  whether  real  or  personal,  growing  out 
of  the  ownership  or  use  of  or  interest  in  real  or  personal 
property,  also  from  interest,  rent,  dividends,  securities, 
or  the  transaction  of  any  business  carried  on  for  gain  or 
profit,  or  gains  or  profits  and  income  derived  from  any 
source  whatever. 

(b)  Income  received  by  estates  of  deceased  persons 
during  the  period  of  administration  or  settlement  of  the 
estate,  shall  be  subject  to  the  normal  and  additional  tax 
and  taxed  to  their  estates,  and  also  such  income  of 
estates  or  any  kind  of  property  held  in  trust,  including 
such  income  accumulated  in  trust  for  the  benefit  of  un- 
born or  unascertained  persons,  or  persons  with  contin- 
gent interests,  and  income  held  for  future  distribution 
under  the  terms  of  the  will  or  trust  shall  be  likewise 


THE    INCOME    TAX    LAW  299 

taxed,  the  tax  in  each  instance,  except  when  the  income 
is  returned  for  the  purpose  of  the  tax  by  the  beneficiary, 
to  be  assessed  to  the  executor,  administrator,  or  trustee, 
as  the  case  may  be : 

Provided,  That  where  the  income  is  to  be  distributed 
annually  or  regularly  between  existing  heirs  or  legatees, 
or  beneficiaries  the  rate  of  tax  and  method  of  computing 
the  same  shall  be  based  in  each  case  upon  the  amount  of 
the  individual  share  to  be  distributed. 

Such  trustees,  executors,  administrators,  and  other 
fiduciaries  are  hereby  indemnified  against  the  claims  or 
demands  of  every  beneficiary  for  all  payments  of  taxes 
which  they  shall  be  required  to  make  under  the  pro- 
visions of  this  title,  and  they  shall  have  credit  for  the 
amount  of  such  payments  against  the  beneficiary  or  prin- 
cipal in  any  accounting  which  they  make  as  such  trustees 
or  other  fiduciaries. 

(c)  For  the  purpose  of  ascertaining  the  gain  derived 
from  the  sale  or  other  disposition  of  property,  real,  per- 
sonal, or  mixed,  acquired  before  March  first,  nineteen 
hundred  and  thirteen,  the  fair  market  price  or  value  of 
such  property  as  of  March  first,  nineteen  hundred  and 
thirteen,  shall  be  the  basis  for  determining  the  amount 
of  such  gain  derived. 

Additional  tax  includes  undistributed  profits. — Sec.  3. 
For  the  purpose  of  the  additional  tax,  the  taxable  in- 
come of  any  individual  shall  include  the  share  to  which 
he  would  be  entitled  of  the  gains  and  profits,  if  divided 
or  distributed,  whether  divided  or  distributed  or  not,  of 
all  corporations,  joint-stock  companies  or  associations,  or 
insurance  companies,  however  created  or  organized, 
formed  or  fraudulently  availed  of  for  the  purpose  of 
preventing  the  imposition  of  such  tax  through  the  me- 
dium of  permitting  such  gains  and  profits  to  accumulate 
instead  of  being  divided  or  distributed ;  and  the  fact  that 
any  such  corporation,  joint-stock  company  or  association, 
or  insurance  company,  is  a  mere  holding  company,  or 


300  INCOME    AND    FEDERAL    TAX    REPORTS 

that  the  gains  and  profits  are  permitted  to  accumulate 
beyond  the  reasonable  needs  of  the  business,  shall  be 
prima  facie  evidence  of  a  fraudulent  purpose  to  escape 
such  tax;  but  the  fact  that  the  gains  and  profits  are  in 
any  case  permitted  to  accumulate  and  become  surplus 
shall  not  be  construed  as  evidence  of  a  purpose  to  escape 
the  said  tax  in  such  case  unless  the  Secretary  of  the 
Treasury  shall  certify  that  in  his  opinion  such  accumula- 
tion is  unreasonable  for  the  purposes  of  the  business. 
When  requested  by  the  Commissioner  of  Internal  Reve- 
nue, or  any  district  collector  of  internal  revenue,  such 
corporation,  joint-stock  company  or  association,  or  in- 
surance company  shall  forward  to  him  a  correct  state- 
ment of  such  gains  and  profits  and  the  names  and  ad- 
dresses of  the  individuals  or  shareholders  who  would  be 
entitled  to  the  same  if  divided  or  distributed. 

Income  exempt  from  law. — Sec.  4.  The  following  income 
shall  be  exempt  from  the  provisions  of  this  title : 

The  proceeds  of  life  insurance  policies  paid  to  indi- 
vidual beneficiaries  upon  the  death  of  the  insured;  thp 
amount  received  by  the  insured,  as  a  return  of  premium 
or  premiums  paid  by  him  under  life  insurance,  endow- 
ment, or  annuity  contracts,  either  during  the  term  or  at 
the  maturity  of  the  term  mentioned  in  the  contract  or 
upon  surrender  of  the  contract;  the  value  of  property 
acquired  by  gift,  bequest,  devise,  or  descent  (but  the  in- 
come from  such  property  shall  be  included  as  income) ; 
interest  upon  the  obligations  of  a  State  or  any  political 
subdivision  thereof  or  upon  the  obligations  of  the  United 
States  (but,  in  the  case  of  obligations  of  the  United 
States  issued  after  September  first,  nineteen  hundred  and 
seventeen,  only  if  and  to  the  extent  provided  in  the  Act 
authorizing  the  issue  thereof)  or  its  possessions  or  se- 
curities issued  under  the  provisions  of  the  Federal  Farm 
Loan  Act  of  July  seventeenth,  nineteen  hundred  and  six- 
teen; the  compensation  of  the  present  President  of  the 
United  States  during  the  term  for  which  he  has  been 


THE   INCOME    TAX   LAW  301 

elected,  and  the  judges  of  the  supreme  and  inferior  courts 
of  the  United  States  now  in  office,  and  the  compensation 
of  all  officers  and  employees  of  a  State,  or  any  political 
subdivision  thereof,  except  when  such  compensation  is 
paid  by  the  United  States  Government. 

Deductions  allowed. — Sec.  5.  That  in  computing  net  in- 
come in  the  case  of  a  citizen  or  resident  of  the  United 
States — 

(a)  For  the  purpose  of  the  tax  there  shall  be  allowed 
as  deductions — 

First.  The  necessary  expenses  actually  paid  in  carry- 
ing on  any  business  or  trade,  not  including  personal,  liv- 
ing, or  family  expenses ; 

Second.  All  interest  paid  within  the  year  on  his  in- 
debtedness except  on  indebtedness  incurred  for  the  pur- 
chase of  obligations  or  securities  the  interest  upon  which 
is  exempt  from  taxation  as  income  under  this  title; 

Third.  Taxes  paid  within  the  year  imposed  by  the 
authority  of  the  United  States  (except  income  and  excess 
profits  taxes)  or  of  its  Territories,  or  possessions,  or 
any  foreign  country,  or  by  the  authority,  of  any  State, 
county,  school  district,  or  municipality,  or  other  taxing 
subdivision  of  any  State,  not  including  those  assessed 
against  local  benefits ; 

Fourth.  Losses  actually  sustained  during  the  year,  in- 
curred in  his  business  or  trade,  or  arising  from  fires, 
storms,  shipwreck,  or  other  casualty,  and  from  theft, 
when  such  losses  are  not  compensated  for  by  insurance 
or  otherwise :  Provided,  That  for  the  purpose  of  ascertain- 
ing the  loss  sustained  from  the  sale  or  other  disposition 
of  property,  real,  personal,  or  mixed,  acquired  before 
March  first,  nineteen  hundred  and  thirteen,  the  fair  mar- 
ket price  or  value  of  such  property  as  of  March  first, 
nineteen  hundred  and  thirteen,  shall  be  the  basis  for  de- 
termining the  amount  of  such  loss  sustained ; 

Fifth.  In  transactions  entered  into  for  profit  but  not 
connected  with  his  business  or  trade,  the  losses  actually 


302  INCOME    AND    FEDERAL    TAX    REPORTS 

sustained  therein  during  the  year  to  an  amount  not  ex- 
ceeding the  profits  arising  therefrom ; 

Sixth.  Debts  due  to  the  taxpayer  actually  ascertained 
to  be  worthless  and  charged  off  within  the  year ; 

Seventh.  A  reasonable  allowance  for  the  exhaustion, 
wear  and  tear  of  property  arising  out  of  its  use  or  em- 
ployment in  the  business  or  trade ; 

Eighth,  (a)  In  the  case  of  oil  and  gas  wells  a  reason- 
able allowance  for  actual  reduction  in  flow  and  produc- 
tion to  be  ascertained  not  by  the  flush  flow,  but  by  the 
settled  production  or  regular  flow;  (b)  in  the  case  of 
mines  a  reasonable  allowance  for  depletion  thereof  not 
to  exceed  the  market  value  in  the  mine  of  the  product 
thereof,  which  has  been  mined  and  sold  during  the  year 
for  which  the  return  and  computation  are  made,  such 
reasonable  allowance  to  be  made  in  the  case  of  both  (a) 
and  (b)  under  rules  and  regulations  to  be  prescribed  by 
the  Secretary  of  the  Treasury : 

Provided,  That  when  the  allowance  authorized  in  (a) 
and  {b)  shall  equal  the  capital  originally  invested,  or  in 
case  of  purchase  made  prior  to  March  1,  1913,  the  fair 
market  value  as  of  that  date,  no  further  allowance  shall 
be  made. 

No  deductions  shall  be  allowed  for  any  amount  paid  out 
for  new  buildings,  permanent  improvements,  or  better- 
ments, made  to  increase  the  value  of  any  property  or 
estate,  and  no  deduction  shall  be  made  for  any  amount 
of  expense  of  restoring  property  or  making  good  the  ex- 
haustion thereof  for  which  an  allowance  is  or  has  been 
made; 

Ninth.  Contributions  or  gifts  actually  made  within 
the  year  to  corporations  or  associations  organized  and 
operated  exclusively  for  religious,  charitable,  scientific, 
or  educational  purposes,  or  to  societies  for  the  preven- 
tion of  cruelty  to  children  or  animals,  no  part  of  the  net 
income  of  which  inures  to  the  benefit  of  any  private 
stockholder  or  individual,  to  an  amount  not  in  excess 


THE    INCOME    TAX    LAW  303 

of  fifteen  per  centum  of  the  taxpayer's  taxable  net  in- 
come as  computed  without  the  benefit  of  this  paragraph. 
Such  contributions  or  gifts  shall  be  allowable  as  deduc- 
tions only  if  verified  under  rules  and  regulations  pre- 
scribed by  the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury. 

Credits  allowed. — (b)  For  the  purpose  of  the  normal 
tax  only,  the  income  embraced  in  a  personal  return  shall 
be  credited  with  the  amount  received  as  dividends  upon 
the  stock  or  from  the  net  earnings  of  any  corporation, 
joint-stock  company  or  association,  trustee,  or  insurance 
company,  which  is  taxable  upon  its  net  income  as  herein- 
after provided; 

(c)  A  like  credit  shall  be  allowed  as  to  the  amount  of 
income,  the  normal  tax  upon  which  has  been  paid  or  with- 
held for  payment  at  the  source  of  the  income  under  the 
provisions  of  this  title. 

Non-resident  aliens — deductions  and  credits  allowed. — Sec. 
6.  That  in  computing  net  income  in  the  case  of  a  non- 
resident alien — 

(a)  For  the  purpose  of  the  tax  there  shall  be  allowed 
as  deductions — 

First.  The  necessary  expenses  actually  paid  in  carry- 
ing on  any  business  or  trade  conducted  by  him  within 
the  United  States  not  including  personal,  living,  or  family 
expenses ; 

Second.  The  proportion  of  all  interest  paid  within  the 
year  by  such  person  on  his  indebtedness  (except  on  in- 
debtedness incurred  for  the  purchase  of  obligations  or 
securities  the  interest  upon  which  is  exempt  from  taxa- 
tion as  income  under  this  title)  which  the  gros3  amount 
of  his  income  for  the  year  derived  from  sources  within 
the  United  States  bears  to  the  gross  amount  of  his  in- 
come for  the  year  derived  from  all  sources  within  and 
without  the  United  States,  but  this  deduction  shal]  be 
allowed  only  if  such  person  includes  in  the  return  re- 


304  1NVOME    AND    FEDERAL    TAX    REPORTS 

quired  by  section  eight  all  the  information  necessary  for 
its  calculation ; 

Third.  Taxes  paid  within  the  year  imposed  by  the  au- 
thority of  the  United  States  (except  income  and  excess 
profits  taxes),  or  of  its  Territories,  or  possessions,  or  by 
the  authority  of  any  State,  county,  school  district,  or 
municipality,  or  other  taxing  subdivision  of  any  State, 
paid  within  the  United  States,  not  including  those  as- 
sessed against  local  benefits ; 

Fourth.  Losses  actually  sustained  during  the  year,  in- 
curred in  business  or  trade  conducted  by  him  within  the 
United  States,  and  losses  of  property  within  the  United 
States  arising  from  fires,  storms,  shipwreck,  or  other 
casualty,  and  from  theft,  when  such  losses  are  not  com- 
pensated for  by  insurance  or  otherwise : 

Provided,  That  for  the  purpose  of  ascertaining  the 
amount  of  such  loss  or  losses  sustained  in  trade,  or  specu- 
lative transactions  not  in  trade,  from  the  same  or  any 
kind  of  property  acquired  before  March  first,  nineteen 
hundred  and  thirteen,  the  fair  market  price  or  value  of 
such  property  as  of  March  first,  nineteen  hundred  and 
thirteen,  shall  be  the  basis  for  determining  the  amount  of 
such  loss  or  losses  sustained; 

Fifth.  In  transactions  entered  into  for  profit  but  not 
connected  with  his  business  or  trade,  the  losses  actually 
sustained  therein  during  the  year  to  an  amount  not  ex- 
ceeding the  profit  arising  therefrom  in  the  United  States ; 

Sixth.  Debts  arising  in  the  course  of  business  or  trade 
conducted  by  him  within  the  United  States  due  to  the 
taxpayer  actually  ascertained  to  be  worthless  and 
charged  off  within  the  year; 

Seventh.  A  reasonable  allowance  for  the  exhaustion, 
wear  and  tear  of  property  within  the  United  States  aris- 
ing out  of  its  use  or  employment  in  the  business  or  trade ; 

(a)  In  the  case  of  oil  and  gas  wells  a  reasonable  al- 
lowance for  actual  reduction  in  flow  and  production  to 
be  ascertained  not  by  the  flush  flow,  but  by  the  settled 


TEE    INCOME    TAX    LAW  305 

production  or  regular  flow;  (b)  in  the  case  of  mines  a 
reasonable  allowance  for  depletion  thereof  not  to  exceed 
the  market  value  in  the  mine  of  the  product  thereof 
which  has  been  mined  and  sold  during  the  year  for  which 
the  return  and  computation  are  made,  such  reasonable 
allowance  to  be  made  in  the  case  of  both  (a)  and  (b) 
under  rules  and  regulations  to  be  prescribed  by  the  Sec- 
retary of  the  Treasury : 

Provided,  That  when  the  allowance  authorized  in  (a) 
and  (b)  shall  equal  the  capital  originally  invested,  or  in 
case  of  purchase  made  prior  to  March  first,  nineteen  hun- 
dred and  thirteen,  the  fair  market  value  as  of  that  date, 
no  further  allowance  shall  be  made.  No  deduction  shall 
be  allowed  for  any  amount  paid  out  for  new  buildings, 
permanent  improvements,  or  betterments,  made  to  in- 
crease the  value  of  any  property  or  estate,  and  no  de- 
duction shall  be  made  for  any  amount  of  expense  of 
restoring  property  or  making  good  the  exhaustion 
thereof  for  which  an  allowance  is  or  has  been  made. 

(b)  There  shall  also  be  allowed  the  credits  specified  by 
subdivisions  {b)  and  (c)  of  section  five. 

(c)  A  nonresident  alien  individual  shall  receive  the 
benefit  of  the  deductions  and  credits  provided  for  in  this 
section  only  by  filing  or  causing  to  be  filed  with  the  col- 
lector of  internal  revenue  a  true  and  accurate  return  of 
his  total  income,  received  from  all  sources,  corporate  or 
otherwise,  in  the  United  States,  in  the  manner  prescribed 
by  this  title ;  and  in  case  of  his  failure  to  file  such  return 
the  collector  shall  collect  the  tax  on  such  income,  and  all 
property  belonging  to  such  nonresident  alien  individual 
shall  be  liable  to  distraint  for  the  tax. 

Personal  exemption. — Sec.  7.  That  for  the  purpose  of 
the  normal  tax  only,  there  shall  be  allowed  as  an  exemp- 
tion in  the  nature  of  a  deduction  from  the  amount  of  the 
net  income  of  each  citizen  or  resident  of  the  United 
States,  ascertained  as  provided  herein,  the  sum  of  $3,000, 
plus  $1,000  additional  if  the  person  making  the  return 


306  INCOME    AND    FEDERAL    TAX    REPORTS 

be  a  head  of  a  family  or  a  married  man  with  a  wife  living 
with  him,  or  plus  the  sum  of  $1,000  additional  if  the 
person  making  the  return  be  a  married  woman  with  a 
husband  living  with  her;  but  in  no  event  shall  this  ad- 
ditional exemption  of  $1,000  be  deducted  by  both  a  hus- 
band and  a  wife:  Provided,  That  only  one  deduction 
of  $4,000  shall  be  made  from  the  aggregate  income  of 
both  husband  and  wife  when  living  together:  Provided 
further,  That  if  the  person  making  the  return  is  the  head 
of  a  family  there  shall  be  an  additional  exemption  of 
$200  for  each  child  dependent  upon  such  person,  if  under 
eighteen  years  of  age,  or  if  incapable  of  self-support  be- 
cause mentally  or  physically  defective,  but  this  provision 
shall  operate  only  in  the  case  of  one  parent  in  the  same 
family:  Provided  further,  That  guardians  or  trustees 
shall  be  allowed  to  make  this  personal  exemption  as  to  in- 
come derived  from  the  property  of  which  such  guardian 
or  trustee  has  charge  in  favor  of  each  ward  or  cestui  que 
trust:  Provided  further,  That  in  no  event  shall  a  ward 
or  cestui  que  trust  be  allowed  a  greater  personal  exemp- 
tion than  as  provided  in  this  section,  from  the  amount; 
of  net  income  received  from  all  sources.  There  shall 
also  be  allowed  an  exemption  from  the  amount  of 
the  net  income  of  estates  of  deceased  citizens  or 
residents  of  the  United  States  during  the  period  of 
administration  or  settlement,  and  of  trust  or  other  estates 
of  citizens  or  residents  of  the  United  States  the  income 
of  which  is  not  distributed  annually  or  regularly  under 
the  provision  of  subdivision  (b)  of  section  two,  the  sum 
of  $3,000,  including  such  deductions  as  are  allowed  under 
section  five. 

Individual  returns — Sec.  8.  (a)  The  tax  shall  be  com- 
puted upon  the  net  income,  as  thus  ascertained,  of  each 
person  subject  thereto,  received  in  each  preceding  cal- 
endar year  ending  December  thirty-first. 

(b)  On  or  before  the  first  day  of  March,  nineteen  hun- 
dred and  seventeen,  and  the  first  day  of  March  in  each 


THE    INCOME    TAX    LAW  307 

year  thereafter,  a  true  and  accurate  return  under  oath 
shall  be  made  by  each  person  of  lawful  age,  except  as 
hereinafter  provided,  having  a  net  income  of  $3,000  or 
over  for  the  taxable  year,  to  the  collector  of  internal 
revenue  for  the  district  in  which  such  person  has  his 
legal  residence  or  principal  place  of  business,  or  if  there 
be  no  legal  residence  or  place  of  business  in  the  United 
States,  then  with  the  collector  of  internal  revenue  at 
Baltimore,  Maryland,  in  such  form  as  the  Commissioner 
of  Internal  Eevenue,  with  the  approval  of  the  Secretary 
of  the  Treasury,  shall  prescribe,  setting  forth  specifically 
the  gross  amount  of  income  from  all  separate  sources, 
and  from  the  total  thereof  deducting  the  aggregate  items 
of  allowances  herein  authorized: 

Provided,  That  the  Commissioner  of  Internal  Revenue 
shall  have  authority  to  grant  a  reasonable  extension  of 
time,  in  meritorious  cases,  for  filing  returns  of  income 
by  persons  residing  or  traveling  abroad  who  are  required 
to  make  and  file  returns  of  income  and  who  are  unable 
to  file  said  returns  on  or  before  March  first  of  each  year : 

Provided  further,  That  the  aforesaid  return  may  be 
made  by  an  agent  when  by  reason  of  illness,  absence,  or 
non-residence  the  person  liable  for  said  return  is  unable 
to  make  and  render  the  same,  the  agent  assuming  the 
responsibility  of  making  the  return  and  incurring  penal- 
ties provided  for  erroneous,  false,  or  fraudulent  return. 

Returns  of  trustees  and  other  fiduciaries. — (c)  Guardians, 
trustees,  executors,  administrators,  receivers,  conserva- 
tors, and  all  persons,  corporations,  or  associations,  act- 
ing in  any  fiduciary  capacity,  shall  make  and  render  a 
return  of  the  income  of  the  person,  trust,  or  estate  for 
whom  or  which  they  act,  and  be  subject  to  all  the  pro- 
visions of  this  title  which  apply  to  individuals.  Such 
fiduciary  shall  make  oath  that  he  has  sufficient  knowledge 
of  the  affairs  of  such  person,  trust,  or  estate  to  enable 
him  to  make  such  return  and  that  the  same  is,  to  the  best 
of  his  knowledge  and  belief,  true  and  correct,  and  be  sub- 


308  INCOME    AND    FEDERAL    TAX    REPORTS 

ject  to  all  the  provisions  of  this  title  which  apply  to  in- 
dividuals : 

Provided,  That  a  return  made  by  one  of  two  or  more 
joint  fiduciaries  filed  in  the  district  where  such  fiduciary 
resides,  under  such  regulations  as  the  Secretary  of  the 
Treasury  may  prescribe,  shall  be  a  sufficient  compliance 
with  the  requirements  of  this  paragraph : 

Provided  further,  That  no  return  of  income  not  exceed- 
ing $3,000  shall  be  required  except  as  in  this  title  other- 
wise provided. 

Returns  of  individual  partners. — (e)  Persons  carrying  on 
business  in  partnership  shall  be  liable  for  income  tax 
only  in  their  individual  capacity,  and  the  share  of  the 
profits  of  the  partnership  to  which  any  taxable  partner 
would  be  entitled  if  the  same  were  divided,  whether  di- 
vided or  otherwise,  shall  be  returned  for  taxation  and  the 
tax  paid  under  the  provisions  of  this  title : 

Provided,  That  from  the  net  distributive  interests  on 
which  the  individual  members  shall  be  liable  for  tax,  nor- 
mal and  additional,  there  shall  be  excluded  their  propor- 
tionate shares  received  from  interest  on  the  obligations 
of  a  State  or  any  political  or  taxing  subdivision  thereof, 
and  upon  the  obligations  of  the  United  States  (if  and  to 
the  extent  that  it  is  provided  in  the  Act  authorizing  the 
issue  of  such  obligations  of  the  United  States  that  they 
are  exempt  from  taxation),  and  its  possessions,  and  that 
for  the  purpose  of  computing  the  normal  tax  there  shall 
be  allowed  a  credit,  as  provided  by  section  five,  sub- 
division (b),  for  their  proportionate  share  of  the  profits 
derived  from  dividends.  Such  partnership,  when  re- 
quested by  the  Commissioner  of  Internal  Eevenue  or 
any  district  collector,  shall  render  a  correct  return  of 
the  earnings,  profits,  and  income  of  the  partnership,  ex- 
cept income  exempt  under  section  four  of  this  Act,  set- 
ting forth  the  items  of  the  gross  income  and  the  deduc- 
tions and  credits  allowed  by  this  title,  and  the  names  and 
addresses  of  the  individuals  who  would  be  entitled  to 


THE    INCOME    TAX    LAW  309 

the  net  earnings,  profits,  and  income,  if  distributed. 
A  partnership  shall  have  the  same  privilege  of  fixing 
and  making  returns  upon  the  basis  of  its  own  fiscal  year 
as  is  accorded  to  corporations  under  this  title.  If  a  fiscal 
year  ends  during  nineteen  hundred  and  sixteen  or  a  sub- 
sequent calendar  year  for  which  there  is  a  rate  of  tax 
different  from  the  rate  for  the  preceding  calendar  year, 
then  (1)  the  rate  for  such  preceding  calendar  year  shall 
apply  to  an  amount  of  each  partner's  share  of  such  part- 
nership profits  equal  to  the  proportion  which  the  part 
of  such  fiscal  year  falling  within  such  calendar  year  bears 
to  the  full  fiscal  year,  and  (2)  the  rate  for  the  calendar 
year  during  which  such  fiscal  year  ends  shall  apply  to 
the  remainder. 

(/)  In  every  return  shall  be  included  the  income  de- 
rived from  dividends  on  the  capital  stock  or  from  the  net 
earnings  of  any  corporation,  joint-stock  company  or  as- 
sociation, or  insurance  company,  except  that  in  the  case 
of  non-resident  aliens  such  income  derived  from  sources 
without  the  United  States  shall  not  be  included. 

(g)  An  individual  keeping  accounts  upon  any  basis 
other  than  that  of  actual  receipts  and  disbursements, 
unless  such  other  basis  does  not  clearly  reflect  his  in- 
come, may,  subject  to  regulations  made  by  the  Commis- 
sioner of  Internal  Revenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  make  his  return  upon  the 
basis  upon  which  his  accounts  are  kept,  in  which  case  the 
tax  shall  be  computed  upon  his  income  as  so  returned. 

Assessment  and  administration. — Sec.  9.  (a)  That  all  as- 
sessments shall  be  made  by  the  Commissioner  of  Internal 
Eevenue  and  all  persons  shall  be  notified  of  the  amount 
for  which  they  are  respectively  liable  on  or  before  the 
first  day  of  June  of  each  successive  year,  and  said 
amounts  shall  be  paid  on  or  before  the  fifteenth  day  of 
June,  except  in  cases  of  refusal  or  neglect  to  make  such 
return  and  in  cases  of  erroneous,  false,  or  fraudulent 
returns,  in  which  cases  the  Commissioner  of  Internal 


310  INCOME    AND    FEDERAL    TAX    REPORTS 

Revenue  shall,  upon  the  discovery  thereof,  at  any  time 
within  three  years  after  said  return  is  due,  or  has  been 
made,  make  a  return  upon  information  obtained  as  pro- 
vided for  in  this  title  or  by  existing  law,  or  require  the 
necessary  corrections  to  be  made,  and  the  assessment 
made  by  the  Commissioner  of  Internal  Revenue  thereon 
shall  be  paid  by  such  person  or  persons  immediately  upon 
notification  of  the  amount  of  such  assessment ;  and  to  any 
sum  or  sums  due  and  unpaid  after  the  fifteenth  day  of 
June  in  any  year,  and  for  ten  days  after  notice  and  de- 
mand thereof  by  the  collector,  there  shall  be  added  the 
sum  of  five  per  centum  on  the  amount  of  tax  unpaid, 
and  interest  at  the  rate  of  one  per  centum  per  month 
upon  said  tax  from  the  time  the  same  became  due,  except 
from  the  estates  of  insane,  deceased,  Or  insolvent  per- 
sons. 

Withholding  of  tax  at  the  source. — (b)  All  persons,  cor- 
porations, partnerships,  associations,  and  insurance  com- 
panies, in  whatever  capacity  acting,  including  lessees  or 
mortgagors  of  real  or  personal  property,  trustees  acting 
in  any  trust  capacity,  executors,  administrators,  receiv- 
ers, conservators,  employers,  and  all  officers  and  em- 
ployees of  the  United  States,  having  the  control,  receipt, 
custody,  disposal,  or  payment  of  interest,  rent,  salaries, 
wages,  premiums,  annuities,  compensation,  remunera- 
tion, emoluments,  or  other  fixed  or  determinable  annual 
or  periodical  gains,  profits,  and  income  of  any  nonresi- 
dent alien  individual,  other  than  income  derived  from 
dividends  on  capital  stock,  or  from  the  net  earnings  of  a 
corporation,  joint-stock  company  or  association,  or  in- 
surance company,  which  is  taxable  upon  its  net  income  as 
provided  in  this  title,  are  hereby  authorized  and  required 
to  deduct  and  withhold  from  such  annual  or  periodical 
gains,  profits,  and  income  such  sum  as  will  be  sufficient  to 
pay  the  normal  tax  imposed  thereon  by  this  title,  and 
shall  make  return  thereof  on  or  before  March  first  of 
each  year  and,  on  or  before  the  time  fixed  by  law  for 


THE    IXCOME    TAX    LAW  311 

the  payment  of  the  tax,  shall  pay  the  amount  withheld  to 
the  officer  of  the  United  States  Government  authorized 
to  receive  the  same;  and  they  are  each  hereby  made 
personally  liable  for  such  tax,  and  they  are  each  hereby 
indemnified  against  every  person,  corporation,  partner- 
ship, association,  or  insurance  company,  or  demand 
whatsoever  for  all  payments  which  they  shall  make  in 
pursuance  and  by  virtue  of  this  title. 

(c)  The  amount  of  the  normal  tax  hereinbefore  im- 
posed shall  also  be  deducted  and  withheld  from  fixed  or 
determinable  annual  or  periodical  gains,  profits  and  in- 
come derived  from  interest  upon  bonds  and  mortgages, 
or  deeds  of  trust  or  other  similar  obligations  of  corpora- 
tions, joint-stock  companies,  associations,  and  insurance 
companies  (if  such  bonds,  mortgages,  or  other  obligations 
contain  a  contract  or  provision  by  which  the  obligee 
agrees  to  pay  any  portion  of  the  tax  imposed  by  this 
title  upon  the  obligee  or  to  reimburse  the  obligee  for  any 
portion  of  the  tax  or  to  pay  the  interest  without  deduc- 
tion for  any  tax  which  the  obligor  may  be  required  or 
permitted  to  pay  thereon  or  to  retain  therefrom  under 
any  law  of  the  United  States)  whether  payable  annually 
or  at  shorter  or  longer  periods  and  whether  such  interest 
is  payable  to  a  nonresident  alien  individual  or  to  an  in- 
dividual citizen  or  resident  of  the  United  States,  subject 
to  the  provisions  of  the  foregoing  subdivision  (b)  of.  this 
section  requiring  the  tax  to  be  withheld  at  the  source 
and  deducted  from  annual  income  and  returned  and  paid 
to  the  Government,  unless  the  person  entitled  to  receive 
such  interest  shall  file  with  the  withholding  agent,  on  or 
before  February  first,  a  signed  notice  in  writing  claiming 
the  benefit  of  an  exemption  under  section  seven  of  this 
title. 

License  required  to  collect  foreign  payments. —  (/)  All  per- 
sons, corporations,  partnerships,  or  associations,  under- 
taking as  a  matter  of  business  or  for  profit  the  collec- 
tion of  foreign  payments  of  interest  or  dividends  by 


312  INCOME    AND    FEDERAL    TAX    REPORTS 

means  of  coupons,  checks,  or  bills  of  exchange  shall  ob- 
tain a  license  from  the  Commissioner  of  Internal  Reve- 
nue,  and  shall  be  subject  to  such  regulations  enabling  the 
Government  to  obtain  the  information  required  under 
this  title,  as  the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury,  shall  pre- 
scribe ;  and  whoever  knowingly  undertakes  to  collect  such 
payments  as  aforesaid  without  having  obtained  a  license 
therefor,  or  without  complying  with  such  regulations, 
shall  be  deemed  guilty  of  a  misdemeanor  and  for  each 
offense  be  fined  in  a  sum  not  exceeding  $5,000,  or  im- 
prisoned for  a  term  not  exceeding  one  year,  or  both,  in 
the  discretion  of  the  court. 

Intent  and  purpose  of  tax. — (g)  The  tax  herein  im- 
posed upon  gains,  profits,  and  incomes  not  falling  under 
the  foregoing  and  not  returned  and  paid  by  virtue  of  the 
foregoing  or  as  otherwise  provided  by  law  shall  be 
assessed  by  personal  return  under  rules  and  regulations 
to  be  prescribed  by  the  Commissioner  of  Internal  Rev- 
enue and  approved  by  the  Secretary  of  the  Treasury. 
The  intent  and  purpose  of  this  title  is  that  all  gains, 
profits,  and  income  of  a  taxable  class,  as  defined  by  this 
title,  shall  be  charged  and  assessed  with  the  correspond- 
ing tax,  normal  and  additional,  prescribed  by  this  title, 
and  said  tax  shall  be  paid  by  the  owner  of  such  income, 
or  the  proper  representative  having  the  receipt,  custody, 
control,  or  disposal  of  the  same.  For  the  purpose  of  this 
ownership  or  liability  shall  be  determined  as  of  the  year 
for  which  a  return  is  required  to  be  ^rendered. 

The  provisions  of  this  section,  except  subdivision  (c), 
relating  to  the  deduction  and  payment  of  the  tax  at  the 
souree  of  income  shall  only  apply  to  the  normal  tax  here- 
inbefore imposed  upon  non-resident  alien  individuals. 

PART  II.— ON  CORPORATIONS. 

Rate  of  tax  on  corporations. — Sec.  10.  (a)  That  there 
shall  be  levied,  assessed,  collected,  and  paid  annually 


TEE   INCOME    TAX   LAW  313 

upon  the  total  net  income  received  in  the  preceding  calen- 
dar year  from  all  sources  by  every  corporation,  joint- 
stock  company  or  association,  or  insurance  company,  or- 
ganized in  the  United  States,  no  matter  how  created  or 
organized,  but  not  including  partnerships,  a  tax  of  two 
per  centum  upon  such  income;  and  a  like  tax  shall  be 
levied,  assessed,  collected,  and  paid  annually  upon  the 
total  net  income  received  in  the  preceding  calendar  year 
from  all  sources  within  the  United  States  by  every  cor- 
poration, joint-stock  company  or  association,  or  insur- 
ance company,  organized,  authorized,  or  existing  under 
the  laws  of  any  foreign  country,  including  interest  on 
bonds,  notes,  or  other  interest-bearing  obligations  of  resi- 
dents, corporate  or  otherwise,  and  including  the  income 
derived  from  dividends  on  capital  stock  or  from  net  earn- 
ings of  resident  corporations,  joint-stock  companies  or 
associations,  or  insurance  companies,  whose  net  income 
is  taxable  under  this  title. 

The  foregoing  tax  rate  shall  apply  to  the  total  net  in- 
come received  by  every  taxable  corporation,  joint-stock 
company  or  association,  or  insurance  company  in  the 
calendar  year  nineteen  hundred  and  sixteen  and  in  each 
year  thereafter,  except  that  if  it  has  fixed  its  own  fiscal 
year  under  the  provisions  of  existing  law,  the  foregoing 
rate  shall  apply  to  the  proportion  of  the  total  net  income 
returned  for  the  fiscal  year  ending  prior  to  December 
thirty-first,  nineteen  hundred  and  sixteen,  which  the 
period  between  January  first,  nineteen  hundred  and  six- 
teen, and  the  end  of  such  fiscal  year  bears  to  the  whole  of 
such  fiscal  year,  and  the  rate  fixed  in  Section  II  of  the 
Act  approved  October  third,  nineteen  hundred  and  thir- 
teen, entitled  "An  Act  to  reduce  tariff  duties  and  to  pro- 
vided revenue  for  the  Government,  and  for  other  pur- 
poses," shall  apply  to  the  remaining  portion  of  the  total 
net  income  returned  for  such  fiscal  year. 

For  the  purpose  of  ascertaining  the  gain  derived  or 
loss  sustained,  from  the  sale  or  other  disposition  by  a 


314  INCOME    AND    FEDERAL    TAX    REPORTS 

corporation,  joint-stock  company,  or  association,  or  in- 
surance company,  of  property,  real,  personal,  or  mixed, 
acquired  before  March  first,  nineteen  hundred  and  thir- 
teen, the  fair  market  price  or  value  of  such  property  as 
of  March  first,  nineteen  hundred  and  thirteen,  shall  be 
the  basis  for  determining  tire  amount  of  such  gain  de- 
rived or  loss  sustained. 

Rate  of  tax  on  undistributed  income. — (b)  In  addition  to 
the  income  tax  imposed  by  subdivision  (a)  of  this  sec- 
tion there  shall  be  levied,  assessed,  collected,  and  paid 
annually  an  additional  tax  of  ten  per  centum  upon  the 
amount,  remaining  undistributed  six  months  after  the  end 
of  each  calendar  or  fiscal  year,  of  the  total  net  income  of 
every  corporation,  joint-stock  company  or  association,  or 
insurance  company  >  received  during  the  year,  as  deter- 
mined for  the  purposes  of  the  tax  imposed  by  such  sub- 
division (a),  but  not  including  the  amount  of  any  income 
taxes  paid  by  it  within  the  year  imposed  by  the  authority 
of  the  United  States. 

The  tax  imposed  by  this  subdivision  shall  not  apply  to 
that  portion  of  such  undistributed  net  income  which  is 
actually  invested  and  employed  in  the  business  or  is  re- 
tained for  employment  in  the  reasonable  requirements  of 
the  business  or  is  invested  in  obligations  of  the  United 
States  issued  after  September  first,  nineteen  hundred  and 
seventeen :  Provided,  That  if  the  Secretary  of  the  Treas- 
ury ascertains  and  finds  that  any  portion  of  such  amount 
so  retained  at  any  time  for  employment  in  the  business  is 
not  so  employed  or  is  not  reasonably  required  in  the  busi- 
ness a  tax  of  fifteen  per  centum  shall  be  levied,  assessed, 
collected,"  and  paid  thereon. 

The  foregoing  tax  rates  shall  apply  to  the  undistrib- 
uted net  income  received  by  every  taxable  corporation, 
joint-stock  company  or  association,  or  insurance  com- 
pany in  the  calendar  year  nineteen  hundred  and  seventeen 
and  in  each  year  thereafter,  except  that  if  it  has  fixed  its 
own  fiscal  year  under  the  provisions  of  existing  law,  the 


THE    INCOME    TAX    LA^Y  315 

foregoing  rates  shall  apply  to  the  proportion  of  the  tax- 
able undistributed  net  income  returned  for  the  fiscal  year 
ending  prior  to  December  thirty-first,  nineteen  hundred 
and  seventeen,  which  the  period  between  January  first, 
nineteen  hundred  and  seventeen,  and  the  end  of  such 
fiscal  year  bears  to  the  whole  of  such  fiscal  year. 

Conditional  and  other  exemptions. — Sec.  11.  (a)  That 
there  shall  not  be  taxed  under  this  title  any  income  re- 
ceived by  any — 

First.  Labor,  agricultural,  or  horticultural  organiza- 
tion; 

Second.  Mutual  savings  bank  not  having  a  capital 
stock  represented  by  shares ; 

Third.  Fraternal  beneficiary  society,  order,  or  associ- 
ation, operating  under  the  lodge  system  or  for  the  exclus- 
ive benefit  of  the  members  of  a  fraternity  itself  operating 
under  the  lodge  system,  and  providing  for  the  payment  of 
life,  sick,  accident,  or  other  benefits  to  the  members  of 
such  society,  order,  or  association  or  their  dependents ; 

Fourth.  Domestic  building  and  loan  association  and 
co-operative  banks  without  capital  stock  organized  and 
operated  for  mutual  purposes  and  without  profit; 

Fifth.    Cemetery  company  owned  and  operated  exclus 
ively  for  the  benefit  of  its  members. 

Sixth.  Corporation  or  association  organized  and  op- 
erated exclusively  for  religious,  charitable,  scientific,  or 
educational  purposes,  no  part  of  the  net  income  of  which 
inures  to  the  benefit  of  any  private  stockholder  or  indi- 
vidual ; 

Seventh.  Business  league,  chamber  of  commerce,  or 
board  of  trade,  not  organized  for  profit  and  no  part  of  the 
net  income  of  which  inures  to  the  benefit  of  any  private 
stockholder  or  individual ; 

Eighth.  Civic  league  or  organization  not  organized  for 
profit  but  operated  exclusively  for  the  promotion  of  social 
welfare ; 

Ninth.     Club  organized  and  operated  exclusively  for 


316  INCOME    AND    FEDERAL    TAX    REPORTS 

pleasure,  recreation,  and  other  non-profitable  purposes, 
no  part  of  the  net  income  of  which  inures  to  the  benefit 
of  any  private  stockholder  or  member; 

Tenth.  Farmers'  or  other  mutual  hail,  cyclone,  or  fire 
insurance  company,  mutual  ditch  or  irrigation  company, 
mutual  or  co-operative  telephone  company,  or  like  or- 
ganization of  a  purely  local  character,  the  income  of 
which  consists  solely  of  assessments,  dues  and  fees  col- 
lected from  members  for  the  sole  purpose  of  meeting  its 
expenses ; 

Eleventh.  Farmers',  fruit  growers',  or  like  association, 
organized  and  operated  as  a  sales  agent  for  the  purpose 
of  marketing  the  products  of  its  members  and  turning 
back  to  them  the  proceeds  of  sales,  less  the  necessary 
selling  expenses,  on  the  basis  of  the  quantity  of  produce 
furnished  by  them ; 

Twelfth.  Corporation  or  association  organized  for  the 
exclusive  purpose  of  holding  title  to  property,  collecting 
income  therefrom,  and  turning  over  the  entire  amount 
thereof,  less  expenses,  to  an  organization  which  itself  is 
exempt  from  the  tax  imposed  by  this  title ;  or 

Thirteenth.  Federal  land  banks  and  national  farm- 
loan  associations  as  provided  in  section  twenty-six  of  the 
Act  approved  July  seventeenth,  nineteen  hundred  and 
sixteen,  entitled  "An  Act  to  provide  capital  for  agricul- 
tural development,  to  create  standard  forms  of  invest- 
ment based  upon  farm  mortgage,  to  equalize  rates  of  in- 
terest upon  farm  loans,  to  furnish  a  market  for  United 
States  bonds,  to  create  Government  depositaries  and  fi- 
nancial agents  for  the  United  States,  and  for  other  pur- 
poses." 

Fourteenth.  Joint-stock  land  banks  as  to  income  de- 
rived from  bonds  or  debentures  of  other  joint-stock  land 
banks  or  any  Federal  land  bank  belonging  to  such  joint- 
stock  land  bank. 

(b)  There  shall  not  be  taxed  under  this  title  any  in- 
come derived  from  any  public  utility  or  from  the  exercise 


THE    INCOME    TAX    LAW  317 

of  any  essential  governmental  function  accruing  to  any 
State,  Territory,  or  the  District  of  Columbia,  or  any  po- 
litical subdivision  of  a  State  or  Territory,  nor  any  income 
accruing  to  the  government  of  the  Philippine  Islands  or 
Porto  Eico,  or  of  any  political  subdivision  of  the  Philip- 
pine Islands  or  Porto  Eico: 

Provided,  That  whenever  any  State,  Territory,  or  the 
District  of  Columbia,  or  any  political  subdivision  of  a 
State  or  Territory,  has,  prior  to  the  passage  of  this  title, 
entered  in  good  faith  into  a  contract  with  any  person  or 
corporation,  the  object  and  purpose  of  which  is  to  ac- 
quire, construct,  operate,  or  maintain  a  public  utility,  no 
tax  shall  be  levied  under  the  provisions  of  this  title  upon 
the  income  derived  from  the  operation  of  such  public 
utility,  so  far  as  the  payment  thereof  will  impose  a  loss 
or  burden  upon  such  State,  Territory,  or  the  District  of 
Columbia,  or  a  political  subdivision  of  a  State  or  Terri- 
tory; but  this  provision  is  not  intended  to  confer  upon 
such  person  or  corporation  any  financial  gain  or  exemp- 
tion or  to  relieve  such  person  or  corporation  from  the 
payment  of  a  tax  as  provided  for  in  this  title  upon  the 
part  or  portion  of  the  said  income  to  which  such  person 
or  corporation  shall  be  entitled  under  such  contract. 

Deductions  allowed  to  corporations  organized  in  United 
States. — Sec.  12.  (a)  In  the  case  of  a  corporation,  joint- 
stock  company  or  association,  or  insurance  company,  or- 
ganized in  the  United  States,  such  net  income  shall  be  as- 
certained by  deducting  from  the  gross  amount  of  its  in- 
come received  within  the  year  from  all  sources — 

First.  All  the  ordinary  and  necessary  expenses  paid 
within  the  year  in  the  maintenance  and  operation  of  its 
business  and  properties,  including  rentals  or  other  pay- 
ments required  to  be  made  as  a  condition  to  the  continued 
use  or  possession  of  property  to  which  the  corporation 
has  not  taken  or  is  not  taking  title,  or  in  which  it  has  no 
equity; 

Second.    All  losses  actually  sustained  and  charged  off 


318  INCOME    AND    FEDERAL    TAX    REPORTS 

within  the  year  and  not  compensated  by  insurance  or 
otherwise,  including  a  reasonable  allowance  for  the  ex- 
haustion, wear  and  tear  of  property  arising  out  of  its  use 
or  employment  in  the  business  or  trade ; 

(a)  in  the  case  of  oil  and  gas  wells  a  reasonable  allow- 
ance for  actual  reduction  in  flow  and  production  to  be  as- 
certained not  by  the  flush  flow  but  by  the  settled  produc- 
tion or  regular  flow ; 

(b)  in  the  case  of  mines  a  reasonable  allowance  for  de- 
pletion thereof  not  to  exceed  the  market  value  in  the  mine 
of  the  product  thereof  which  has  been  mined  and  sold 
during  the  year  for  which  the  return  and  computation 
are  made,  such  reasonable  allowance  to  be  made  in  the 
case  of  both  (a)  and  (b)  under  rules  and  regulations  to 
be  prescribed  by  the  Secretary  of  the  Treasury: 

Provided,  That  when  the  allowance  authorized  in  (a) 
and  (b)  shall  equal  the  capital  originally  invested,  or  in 
case  of  purchase  made  prior  to  March  first,  nineteen 
hundred  and  thirteen,  the  fair  market  value  as  of  that 
date,  no  further  allowance  shall  be  made ;  and 

(c)  in  the  case  of  insurance  companies,  the  net  addi- 
tion, if  any,  required  by  law  to  be  made  within  the  year 
to  reserve  funds  and  the  sums  other  than  dividends  paid 
within  the  year  on  policy  and  annuity  contracts : 

Provided,  That  no  deduction  shall  be  allowed  for  any 
amount  paid  out  for  new  buildings,  permanent  improve- 
ments, or  betterments  made  to  increase  the  value  of  any 
property  or  estate,  and  no  deduction  shall  be  made  for 
any  amount  of  expense  of  restoring  property  or  making 
good  the  exhaustion  thereof  for  which  an  allowance  is 
or  has  been  made: 

Provided  further,  That  mutual  fire  and  mutual  em- 
ployers' liability  and  mutual  workmen's  compensation 
and  mutual  casualty  insurance  companies  requiring  their 
members  to  make  premium  deposits  to  provide  for  losses 
and  expenses  shall  not  return  as  income  any  portion  of 
the  premium  deposits  returned  to  their  policyholders,  but 


TEE    INCOME    TAX    LAW  319 

shall  return  as  taxable  income  all  income  received  by 
them  from  all  other  sources  plus  such  portions  of  the 
premium  deposits  as  are  retained  by  the  companies  for 
purposes  other  than  the  payment  of  losses  and  expenses 
and  reinsurance  reserves : 

Provided  further,  That  mutual  marine  insurance  com- 
panies shall  include  in  their  return  of  gross  income  gross 
premiums  collected  and  received  by  them  less  amounts 
paid  for  reinsurance,  but  shall  be  entitled  to  include  in 
deductions  from  gross  income  amounts  repaid  to  policy 
holders  on  account  of  premiums  previously  paid  by  them 
and  interest  paid  upon  such  amounts  between  the  ascer- 
tainment thereof  and  the  payment  thereof,  and  life  in- 
surance companies  shall  not  include  as  income  in  any 
year  such  portion  of  any  actual  premium  received  from 
any  individual  policyholder  as  shall  have  been  paid  back 
or  credited  to  such  individual  policyholder,  or  treated  as 
an  abatement  of  premium  of  such  individual  policyholder, 
within  such  year ; 

Third.  The  amount  of  interest  paid  within  the  year  on 
its  indebtedness  (except  on  indebtedness  incurred  for  the 
purchase  of  obligations  or  securities  the  interest  upon 
which  is  exempt  from  taxation  as  income  under  this  title) 
to  an  amount  of  such  indebtedness  not  in  excess  of  the 
sum  of  (a)  the  entire  amount  of  the  paid-up  capital  stock 
outstanding  at  the  close  of  the  year,  or,  if  no  capital  stock 
the  entire  amount  of  capital  employed  in  the  business  at 
the  close  of  the  year,  and  (b)  one-half  of  its  interest- 
bearing  indebtedness  then  outstanding: 

Provided,  That  for  the  purpose  of  this  title  preferred 
capital  stock  shall  not  be  considered  interest-bearing  in- 
debtedness, and  interest  or  dividends  paid  upon  this  stock 
shall  not  be  deductible  from  gross  income : 

Provided  further,  That  in  cases  wherein  shares  of  capi- 
tal stock  are  issued  without  par  or  nominal  value,  the 
amount  of  paid-up  capital  stock,  within  the  meaning  of 
this  section,  as  represented  by  such  shares,  will  be  the 


320  INCOME    AND    FEDERAL    TAX    REPORTS 

amount  of  cash,  or  its  equivalent,  paid  or  transferred  to 
the  corporation  as  a  consideration  for  such  shares : 

Provided  further,  That  in  the  case  of  indebtedness 
wholly  secured  by  property  collateral,  tangible  or  in- 
tangible, the  subject  of  sale  or  hypothecation  in  the  or- 
dinary business  of  such  corporation,  joint-stock  company 
or  association  as  a  dealer  only  in  the  property  constitut- 
ing such  collateral,  or  in  loaning  the  funds  thereby  pro- 
cured, the  total  interest  paid  by  such  corporation,  com- 
pany, or  association  within  the  year  on  any  such  indebt- 
edness may  be  deducted  as  a  part  of  its  expenses  of  do- 
ing business,  but  interest  on  such  indebtedness  shall  only 
be  deductible  on  an  amount  of  such  indebtedness  not  in 
excess  of  the  actual  value  of  such  property  collateral: 

Provided  further,  That  in  the  case  of  bonds  or  other  in- 
debtedness, which  have  been  issued  with  a  guaranty  that 
the  interest  payable  thereon  shall  be  free  from  taxation, 
no  deduction  for  the  payment  of  the  tax  herein  imposed, 
or  any  other  tax  paid  pursuant  to  such  guaranty,  shall  be 
allowed;  and  in  the  case  of  a  bank,  banking  association, 
loan  or  trust  company,  interest  paid  within  the  year  on 
deposits  or  on  moneys  received  for  investment  and  se- 
cured by  interest-bearing  certificates  of  indebtedness  is- 
sued by  such  bank,  banking  association,  loan  or  trust  com- 
pany shall  be  deducted; 

Fourth.  Taxes  paid  within  the  year  imposed  by  the 
authority  of  the  United  States  (except  income  and  excess 
profits  taxes),  or  of  its  Territories,  or  possessions,  or  any 
foreign  country,  or  by  the  authority  of  any  State,  county, 
school  district,  or  municipality,  or  other  taxing  subdi- 
vision of  any  State,  not  including  those  assessed  against 
local  benefits. 

Deductions  allowed  to  foreign  corporations. — (b)  In  the 
case  of  a  corporation,  joint-stock  company  or  association, 
or  insurance  company,  organized,  authorized,  or  existing 
under  the  laws  of  any  foreign  country,  such  net  income 
shall  be  ascertained  by  deducting  from  the  gross  amount 


THE   INCOME    TAX    LAW  321 

of  its  income  received  within  the  year  from  all  sources 
within  the  United  States — 

First.  All  the  ordinary  and  necessary  expenses  ac- 
tually paid  within  the  year  out  of  earnings  in  the  main- 
tenance and  operation  of  its  business  and  property  within 
the  United  States,  including  rentals  or  other  payments  re- 
quired to  be  made  as  a  condition  to  the  continued  use  or 
possession  of  property  to  which  the  corporation  has  not 
taken  or  is  not  taking  title,  or  in  which  it  has  no  equity ; 

Second.  All  losses  actually  sustained  within  the  year 
in  business  or  trade  conducted  by  it  within  the  United 
States  and  not  compensated  by  insurance  or  otherwise, 
including  a  reasonable  allowance  for  the  exhaustion,  wear 
and  tear  of  property  arising  out  of  its  use  or  employment 
in  the  business  or  trade ; 

(a)  and  in  the  case  of  oil  and  gas  wells  a  reasonable  al- 
lowance for  actual  reduction  in  flow  and  production  to  be 
ascertained  not  by  the  flush  flow,  but  by  the  settled 
production  or  regular  flow; 

(b)  in  the  case  of  mines  a  reasonable  allowance  for  de- 
pletion thereof  not  to  exceed  the  market  value  in  the  mine 
of  the  product  thereof  which  has  been  mined  and  sold 
during  the  year  for  which  the  return  and  computation  are 
made,  such  reasonable  allowance  to  be  made  in  the  case 
of  both  (a)  and  (b)  under  rules  and  regulations  to  be 
prescribed  by  the  Secretary  of  the  Treasury:  Provided. 
That  when  the  allowance  authorized  in  (a)  and  (b)  shall 
equal  the  capital  originally  invested,  or  in  case  of  pur- 
chase made  prior  to  March  first,  nineteen  hundred  and 
thirteen,  the  fair  market  value  as  of  that  date,  no  fur- 
ther allowance  shall  be  made ;  and 

(c)  in  the  case  of  insurance  companies  the  net  addition, 
if  any,  required  by  law  to  be  made  within  the  year  to  re- 
serve funds  and  the  sums  other  than  dividends  paid  within 
the  year  on  policy  and  annuity  contracts :  Provided,  That 
no  deduction  shall  be  allowed  for  any  amount  paid  out 
for  new  buildings,  permanent  improvements,  or  better- 


322        INCOME    AND    FEDERAL    TAX    REPORTS 

ments,  made  to  increase  the  value  of  any  property  or 
estate,  and  no  deduction  shall  be  made  for  any  amount  of 
expense  of  restoring  property  or  making  good  the  ex- 
haustion thereof  for  which  an  allowance  is  or  has  been 
made :  Provided  further,  That  mutual  fire  and  mutual  em- 
ployers' liability  and  mutual  workmen's  compensation 
and  mutual  casualty  insurance  companies  requiring  their 
members  to  make  premium  deposits  to  provide  for  losses 
and  expenses  shall  not  return  as  income  any  portion  of 
the  premium  deposits  returned  to  their  policyholders,  but 
shall  return  as  taxable  income  all  income  received  by 
them  from  all  other  sources  plus  such  portions  of  the  pre- 
mium deposits  as  are  retained  by  the  companies  for  pur- 
poses other  than  the  payment  of  losses  and  expenses  and 
reinsurance  reserves :  Provided  further,  That  mutual  ma- 
rine insurance  companies  shall  include  in  their  return  of 
gross  income  gross  premiums  collected  and  received  by 
them  less  amounts  paid  for  reinsurance,  but  shall  be  en- 
titled to  include  in  deductions  from  gross  income  amounts 
repaid  to  policyholders  on  account  of  premiums  previ- 
ously paid  by  them,  and  interest  paid  upon  such  amounts 
between  the  ascertainment  thereof  and  the  payment 
thereof,  and  life  insurance  companies  shall  not  include  as 
income  in  any  year  such  portion  of  any  actual  premium 
received  from  any  individual  policyholder  as  shall  have 
been  paid  back  or  credited  to  such  individual  policy- 
holder, or  treated  as  an  abatement  of  such  individual 
policyholder,  within  such  year ; 

Third.  The  amount  of  interest  paid  within  the  year  on 
its  indebtedness  (except  on  indebtedness  incurred  for  the 
purchase  of  obligations  or  securities  the  interest  upon 
which  is  exempt  from  taxation  as  income  under  this  title) 
to  an  amount  of  such  indebtedness  not  in  excess  of  the 
proportion  of  the  sum  of  (a)  the  entire  amount  of  the 
paid-up  capital  stock  outstanding  at  the  close  of  the  year, 
or,  if  no  capital  stock,  the  entire  amount  of  the  capital 
employed  in  the  business  at  the  close  of  the  year,  and  (b) 


THE    IX COME    TAX    LAW  323 

one-half  of  its  interest-bearing  indebtedness  then  out- 
standing, which  the  gross  amount  of  its  income  for  the 
year  from  business  transacted  and  capital  invested  within 
the  United  States  bears  to  the  gross  amount  of  its  income 
derived  from  all  sources  within  and  without  the  United 
States :  Provided,  That  in  the  case  of  bonds  or  other  in- 
debtedness which  have  been  issued  with  a  guaranty  that 
the  interest  payable  thereon  shall  be  free  from  taxation, 
no  deduction  for  the  payment  of  the  tax  herein  imposed 
or  any  other  tax  paid  pursuant  to  such  guaranty  shall  be 
allowed ;  and  in  case  of  a  bank,  banking  association,  loan 
or  trust  company,  or  branch  thereof,  interest  paid  within 
the  year  on  deposits  by  or  on  moneys  received  for  invest- 
ment from  either  citizens  or  residents  of  the  United  States 
and  secured  by  interest-bearing  certificates  of  indebted- 
ness issued  by  such  bank,  banking  association,  loan  or 
trust  company,  or  branch  thereof; 

Fourth.  Taxes  paid  within  the  year  imposed  by  the 
authority  of  the  United  States  (except  income  and  excess 
profits  taxes),  or  of  its  Territories,  or  possessions,  or  by 
the  authority  of  any  State,  county,  school  district,  or  mu- 
nicipality, or  other  taxing  subdivision  of  any  State,  paid 
within  the  United  States,  not  including  those  assessed 
against  local  benefits. 

Guarantee  or  reserve  funds  of  assessment  insurance  com- 
panies.— (c)  In  the  case  of  assessment  insurance  compan- 
ies, whether  domestic  or  foreign,  the  actual  deposit  of 
sums  with  State  or  Territorial  officers,  pursuant  to  law, 
as  additions  to  guarantee  or  reserve  funds  shall  be 
treated  as  being  payments  required  by  law  to  reserve 
funds. 

Corporation  returns. — Sec.  13.  (a)  The  tax  shall  be 
computed  upon  the  net  income,  as  thus  ascertained,  re- 
ceived within  each  preceding  calendar  year  ending  De- 
cember thirty-first:  Provided,  That  any  corporation, 
joint-stock  company  or  association,  or  insurance  com- 
pany, subject  to  this  tax,  may  designate  the  last  day  of 


324  INCOME    AND    FEDERAL    TAX    REPORTS 

any  month  in  the  year  as  the  day  of  the  closing  of  its 
fiscal  year  and  shall  be  entitled  to  have  the  tax  payable 
by  it  computed  upon  the  basis  of  the  net  income  ascer- 
tained as  herein  provided  for  the  year  ending  on  the  day 
so  designated  in  the  year  preceding  the  date  of  assess- 
ment instead  of  upon  the  basis  of  the  net  income  for  the 
calendar  year  preceding  the  date  of  assessment;  and  it 
shall  give  notice  of  the  day  it  has  thus  designated  as  the 
closing  of  its  fiscal  year  to  the  collector  of  the  district  in 
which  its  principal  business  office  is  located  at  any  time 
not  less  than  thirty  days  prior  to  the  first  day  of  March 
of  the  year  in  which  its  return  would  be  filed  if  made 
upon  the  basis  of  the  calendar  year ; 

(b)  Every  corporation,  joint-stock  company  or  associ- 
ation, or  insurance  company,  subject  to  the  tax  herein  im- 
posed, shall,  on  or  before  the  first  day  of  March,  nineteen 
hundred  and  seventeen,  and  the  first  day  of  March  in  each 
year  thereafter,  or,  if  it  has  designated  a  fiscal  year  for 
the  computation  of  its  tax,  then  within  sixty  days  after 
the  close  of  such  fiscal  year  ending  prior  to  December 
thirty-first,  nineteen  hundred  and  sixteen,  and  the  close 
of  each  such  fiscal  year  thereafter,  render  a  true  and  ac- 
curate return  of  its  annual  net  income  in  the  manner  and 
form  to  be  prescribed  by  the  Commissioner  of  Internal 
Eevenue,  with  the  approval  of  the  Secretary  of  the  Treas- 
ury, and  containing  such  facts,  data,  and  information  as 
are  appropriate  and  in  the  opinion  of  the  commissioner 
necessary  to  determine  the  correctness  of  the  net  income 
returned  and  to  carry  out  the  provisions  of  this  title. 

The  return  shall  be  sworn  to  by  the  president,  vice- 
president,  or  other  principal  officer,  and  by  the  treasurer 
or  assistant  treasurer. 

The  return  shall  be  made  to  the  collector  of  the  district 
in  which  is  located  the  principal  office  of  the  corporation, 
company,  or  association,  where  are  kept  its  books  of  ac- 
count and  other  data  from  which  the  return  is  prepared, 
or  in  the  case  of  a  foreign  corporation,  company,  or  as- 


THE    INCOME    TAX    LAW  325 

sociation,  to  the  collector  of  the  district  in  which  is  lo- 
cated its  principal  place  of  business  in  the  United  States, 
or  if  it  have  no  principal  place  of  business,  office,  or 
agency  in  the  United  States,  then  to  the  collector  of  in- 
ternal revenue  at  Baltimore,  Maryland. 

All  such  returns  shall  as  received  be  transmitted  forth- 
with by  the  collector  to  the  Commissioner  of  Internal 
Eevenue ; 

(c)  In  case  wherein  receivers,  trustees  in  bankruptcy, 
or  assignees  are  operating  the  property  or  business  of 
corporations,  joint-stock  companies  or  associations,  or  in- 
surance companies,  subject  to  tax  imposed  by  this  title, 
such  receivers,  trustees,  or  assignees  shall  make  returns 
of  net  income  as  and  for  such  corporations,  joint-stock 
companies  or  associations,  and  insurance  companies,  in 
the  same  manner  and  form  as  such  organizations  are 
hereinbefore  required  to  make  returns,  and  any  income 
tax  due  on  the  basis  of  such  returns  made  by  receivers, 
trustees,  or  assignees  shall  be  assessed  and  collected  in 
the  same  manner  as  if  assessed  directly  against  the  or- 
ganizations of  whose  businesses  or  properties  they  have 
custody  and  control ; 

(d)  A  corporation,  joint-stock  company  or  association, 
or  insurance  company,  keeping  accounts  upon  any  basis 
other  than  that  of  actual  receipts  and  disbursements,  un- 
less such  other  basis  does  not  clearly  reflect  its  income, 
may,  subject  to  regulations  made  by  the  Commissioner  of 
Internal  Revenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  make  its  return  upon  the  basis  upon  which 
its  accounts  are  kept,  in  which  case  the  tax  shall  be  com- 
puted upon  its  income  as  so  returned; 

Withholding  of  tax  at  the  source. — (e)  All  the  provisions 
of  this  title  relating  to  the  tax  authorized  and  required  to 
be  deducted  and  withheld  and  paid  to  the  officer  of  the 
United  States  Government  authorized  to  receive  the  same 
from  the  income  of  non-resident  alien  individuals  from 
sources  within  the  United  States  shall  be  made  applicable 


326  INCOME    AND    FEDERAL    TAX    REPORTS 

to  the  tax  imposed  by  subdivision  (a)  of  section  ten  upon 
incomes  derived  from  interest  upon  bonds  and  mortgages 
or  deeds  Of  trust  or  similar  obligations  of  domestic  or 
other  resident  corporations,  joint-stock  companies  or  as- 
sociations, and  insurance  companies  by  non-resident  alien 
firms,  co-partnerships,  companies,  corporations,  joint- 
stock  companies  or  associations,  and  insurance  compan- 
ies, not  engaged  in  business  or  trade  within  the  United 
States  and  not  having  any  office  or  place  of  business 
therein ; 

(/)  Likewise,  all  the  provisions  of  this  title  relating  to 
the  tax  authorized  and  required  to  be  deducted  and  with- 
held and  paid  to  the  officer  of  the  United  States  Govern- 
ment authorized  to  receive  the  same  from  the  income  of 
non-resident  alien  individuals  from  sources  within  the 
United  States  shall  be  made  applicable  to  income  derived 
from  dividends  upon  the  capital  stock  or  from  the  net 
earnings  of  domestic  or  other  resident  corporations,  joint- 
stock  companies  or  associations,  and  insurance  compan- 
ies by  non-resident  alien  companies,  corporations,  joint- 
stock  companies  or  associations,  and  insurance  companies 
not  engaged  in  business  or  trade  within  the  United  States 
and  not  having  any  office  or  place  of  business  therein. 

Assessment  and  administration. — Sec.  14.  (a)  All  assess- 
ments shall  be  made  and  the  several  corporations,  joint- 
stock  companies  or  associations,  and  insurance  compan- 
ies shall  be  notified  of  the  amount  for  which  they  are  re- 
spectively liable  on  or  before  the  first  day  of  June  of  each 
successive  year,  and  said  assessment  shall  be  paid  on  or 
before  the  fifteenth  day  of  June : 

Provided,  That  every  corporation,  joint-stock  company 
or  association,  and  insurance  company,  computing  taxes 
upon  the  income  of  the  fiscal  year  which  it  may  designate 
in  the  manner  hereinbefore  provided,  shall  pay  the  taxes 
due  under  its  assessment  within  one  hundred  and  five 
days  after  the  date  upon  which  it  is  required  to  file  its  list 
or  return  of  income  for  assessment ;  except  in  cases  of  re- 


THE    INCOME    TAX    L.UY  327 

fusal  or  neglect  to  make  such  return,  and  in  cases  of  er- 
roneous, false,  or  fraudulent  returns,  in  which  cases  the 
Commissioner  of  Internal  Eevenue  shall,  upon  the  dis- 
covery thereof,  at  any  time  within  three  years  after  said 
return  is  due,  make  a  return  upon  information  obtained 
as  provided  for  in  this  title  or  by  existing  law;  and  the 
assessment  made  by  the  Commissioner  of  Internal  Eeve- 
nue thereon  shall  be  paid  by  such  corporation,  joint-stock 
company  or  association,  or  insurance  company  immedi- 
ately upon  notification  of  the  amount  of  such  assessment ; 
and  to  any  sum  or  sums  due  and  unpaid  after  the  fif- 
teenth day  of  June  in  any  year,  or  after  one  hundred  and 
five  days  from  the  date  on  which  the  return  of  income  is 
required  to  be  made  by  the  taxpayer,  and  after  ten  days' 
notice  and  demand  thereof  by  the  collector,  there  shall  be 
added  the  sum  of  five  per  centum  on  the  amount  of  tax 
unpaid  and  interest  at  the  rate  of  one  per  centum  per 
month  upon  said  tax  from  the  time  the  same  becomes  due : 
Provided,  That  upon  the  examination  of  any  return  of  in- 
come made  pursuant  to  this  title,  the  act  of  August  fifth, 
nineteen  hundred  and  nine,  entitled,  "An  act  to  provide 
revenue,  equalize  duties  and  encourage  the  industries  of 
the  United  States,  and  for  other  purposes,"  and  the  act 
of  October  third,  nineteen  hundred  and  thirteen,  entitled, 
"An  act  to  reduce  tariff  duties  and  to  provide  revenue  for 
the  Government,  and  for  other  purposes,"  if  it  shall  ap- 
pear that  amounts  of  tax  have  been  paid  in  excess  of 
those  properly  due,  the  taxpayer  shall  be  permitted  to 
present  a  claim  for  refund  thereof  notwithstanding  the 
provisions  of  section  thirty-two  hundred  and  twenty- 
eight  of  the  Revised  Statutes ; 

(b)  When  the  assessment  shall  be  made,  as  provided  in 
this  title,  the  returns,  together  with  any  corrections 
thereof  which  may  have  been  made  by  the  commissioner, 
shall  be  filed  in  the  office  of  the  Commissioner  of  Internal 
Revenue  and  shall  constitute  public  records  and  be  open 
to  inspection  as  such:  Provided,  That  any  and  all  such 


328  INCOME    AND    FEDERAL    TAX    REPORTS 

returns  shall  be  open  to  inspection  only  upon  the  order  of 
the  President,  under  rules  and  regulations  to  be  pre- 
scribed by  the  Secretary  of  the  Treasury  and  approved 
by  the  President :  Provided  further,  That  the  proper  offi- 
cers of  any  State  imposing  a  general  income  tax  may, 
upon  the  request  of  the  governor  thereof,  have  access  to 
said  returns  or  to  an  abstract  thereof,  showing  the  name 
and  income  of  each  such  corporation,  joint-stock  company 
or  association,  or  insurance  company,  at  such  times  and 
in  such  manner  as  the  Secretary  of  the  Treasury  may 
prescribe; 

(c)  If  any  of  the  corporations,  joint-stock  companies  or 
associations,  or  insurance  companies  aforesaid  shall  re- 
fuse or  neglect  to  make  a  return  at  the  time  or  times 
hereinbefore  specified  in  each  year,  or  shall  render  a  false 
or  fraudulent  return,  such  corporation,  joint-stock  com- 
pany or  association,  or  insurance  company  shall  be  liable 
to  a  penalty  of  not  exceeding  $10,000 :  Provided,  That  the 
Commissioner  of  Internal  Eevenue  shall  have  authority, 
in  the  case  of  either  corporations  or  individuals,  to  grant 
a  reasonable  extension  of  time  in  meritorious  cases,  as  he 
may  deem  proper ; 

(d)  That  section  thirty- two  hundred  and  twenty-five  of 
the  Eevised  Statutes  of  the  United  States  be,  and  the 
same  is  hereby,  amended  so  as  to  read  as  follows : 

"Sec.  3225.  When  a  second  assessment  is  made  in  case 
of  any  list,  statement,  or  return,  which  in  the  opinion  of 
the  collector  or  deputy  collector  was  false  or  fraudulent, 
or  contained  any  understatement  or  undervaluation,  no 
tax  collected  under  such  assessment  shall  be  recovered  by 
any  suit  unless  it  is  proved  that  the  said  list,  statement, 
or  return  was  not  false  nor  fraudulent  and  did  not  con- 
tain any  understatement  or  undervaluation ;  but  this  sec- 
tion shall  not  apply  to  statements  or  returns  made  or  to 
be  made  in  good  faith  under  the  laws  of  the  United  States 
regarding  annual  depreciation  of  oil  or  gas  wells  and 
mines." 


THE   INCOME    TAX   LAW  329 

PART   III.— GENERAL   ADMINISTRATIVE    PROVISIONS 

Meaning  of  "States  and  United  States." — Sec.  15.  That 
the  word  "State"  or  "United  States"  when  used  in  this 
title  shall  be  construed  to  include  any  Territory,  the  Dis- 
trict of  Columbia,  Porto  Rico,  and  the  Philippine  Islands, 
when  such  construction  is  necessary  to  carry  out  its  pro- 
visions. 

General  provisions. — Sec.  16,  That  sections  thirty-one 
hundred  and  sixty-seven,  thirty-one  hundred  and  seventy- 
two,  thirty-one  hundred  and  seventy-three,  and  thirty-one 
hundred  and  seventy-six  of  the  Revised  Statutes  of  the 
United  States  as  amended  are  hereby  amended  so  as  to 
read  as  follows: 

"Sec.  3167.  It  shall  be  unlawful  for  any  collector, 
deputy  collector,  agent,  clerk,  or  other  officer  or  employee 
of  the  United  States  to  divulge  or  to  make  known  in  any 
manner  whatever  not  provided  by  law  to  any  person  the 
operations,  style  of  work,  or  apparatus  of  any  manufac- 
turer or  producer  visited  by  him  in  the  discharge  of  his 
official  duties,  or  the  amount  or  source  of  income,  profits, 
losses,  expenditures,  or  any  particular  thereof,  set  forth 
or  disclosed  in  any  income  return,  or  to  permit  any  in- 
come return  or  copy  thereof  or  any  book  containing  any 
abstract  or  particulars  thereof  to  be  seen  or  examined  by 
any  person  except  as  provided  by  law ;  and  it  shall  be  un- 
lawful for  any  person  to  print  or  publish  in  any  manner 
whatever  not  provided  by  law  any  income  return  or  any 
part  thereof  or  source  of  income,  profits,  losses,  or  ex- 
penditures appearing  in  any  income  return;  and  any  of- 
fense against  the  foregoing  provision  shall  be  a  misde- 
meanor and  be  punished  by  a  fine  not  exceeding  $1,000  or 
by  imprisonment  not  exceeding  one  year,  or  both,  at  the 
discretion  of  the  court;  and  if  the  offender  be  an  officer 
or  employee  of  the  United  States  he  shall  be  dismissed 
from  office  or  discharged  from  employment." 

"Sec.  3172.    Every  collector  shall,  from  time  to  time. 


330  INCOME    AND    FEDERAL    TAX    REPORTS 

cause  his  deputies  to  proceed  through  every  part  of  his 
district  and  inquire  after  and  concerning  all  persons 
therein  who  are  liable  to  pay  any  internal-revenue  tax, 
and  all  persons  owning  or  having  the  care  and  manage- 
ment of  any  objects  liable  to  pay  any  tax,  and  to  make  a 
list  of  such  persons  and  enumerate  said  objects." 

"Sec.  3173.  It  shall  be  the  duty  of  any  person,  partner- 
ship, firm,  association,  or  corporation,  made  liable  to  any 
duty,  special  tax,  or  other  tax  imposed  by  law,  when  not 
otherwise  provided  for,  (1)  in  case  of  a  special  tax,  on  or 
before  the  thirty-first  day  of  July  in  each  year,  (2)  in  case 
of  income  tax  on  or  before  the  first  day  of  March  in  each 
year,  or  on  or  before  the  last  day  of  the  sixty-day  period 
next  following  the  closing  date  of  the  fiscal  year  for  which 
it  makes  a  return  of  its  income,  and  (3)  in  other  cases  be- 
fore the  day  on  which  the  taxes  accrue,  to  make  a  list  or 
return,  verified  by  oath,  to  the  collector  or  a  deputy  of  the 
district  where  located,  of  the  articles  or  objects,  including 
the  amount  of  annual  income  charged  with  a  duty  or  tax, 
the  quantity  of  goods,  wares,  and  merchandise,  made  or 
sold  and  charged  with  a  tax,  the  several  rates  and  aggre- 
gate amount,  according  to  the  forms  and  regulations  pre- 
scribed by  the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury,  for  which 
such  person,  partnership,  firm,  association,  or  corpora- 
tion is  liable: 

Provided,  That  if  any  person  liable  to  pay  any  duty  oi 
tax,  or  owning,  possessing,  or  having  the  care  or  manage- 
ment of  property,  goods,  wares,  and  merchandise,  articles 
or  objects  liable  to  pay  any  duty,  tax,  or  license,  shall  fail 
to  make  and  exhibit  a  list  or  return  required  by  law,  but 
shall  consent  to  disclose  the  particulars  of  any  and  all  the 
property,  goods,  wares,  and  merchandise,  articles,  and  ob- 
jects liable  to  pay  any  duty  or  tax,  or  any  business  or  oc- 
cupation liable  to  pay  any  tax  as  aforesaid,  then,  and  in 
that  case,  it  shall  be  the  duty  of  the  collector  or  deputy 
collector  to  make  such  list  or  return,  which,  being  dis- 


THE   IX COME    TAX   LAW  331 

tinctly  read,  consented  to,  and  signed  and  verified  by  oath 
by  the  person  so  owning,  possessing,  or  having  the  care 
and  management  as  aforesaid,  may  be  received  as  the  list 
of  such  person : 

Provided  further,  That  in  case  no  annual  list  or  return 
has  been  rendered  by  such  person  to  the  collector  or  dep- 
uty collector  as  required  by  law,  and  the  person  shall  be 
absent  from  his  or  her  residence  or  place  of  business  at 
the  time  the  collector  or  a  deputy  collector  shall  call  for 
the  annual  list  or  return,  it  shall  be  the  duty  of  such  col- 
lector or  deputy  collector  to  leave  at  such  place  of  resi- 
dence or  business,  with  some  one  of  suitable  age  and  dis- 
cretion, if  such  be  present,  otherwise  to  deposit  in  the 
nearest  post  office,  a  note  or  memorandum  addressed  to 
such  person,  requiring  him  or  her  to  render  to  such  col- 
lector or  deputy  collector  the  list  or  return  required  by 
law  within  ten  days  from  the  date  of  such  note  or  memor- 
andum, verified  by  oath.  And  if  any  person,  on  being 
notified  or  required  as  aforesaid,  shall  refuse  or 
neglect  to  render  such  list  or  return  within  the  time  re- 
quired as  aforesaid,  or  whenever  any  person  who  is  re- 
quired to  deliver  a  monthly  or  other  return  of  objects 
subject  to  tax  fails  to  do  so  at  the  time  required,  or 
delivers  any  return  which,  in  the  opinion  of  the  col- 
lector, is  erroneous,  false,  or  fraudulent,  or  contains 
any  undervaluation  or  understatement,  or  refuses  to 
allow  any  regularly  authorized  Government  officer  to 
examine  the  books  of  such  person,  firm,  or  corporation,  it 
shall  be  lawful  for  the  collector  to  summon  such  person, 
or  any  other  person  having  possession,  custody,  or  care 
of  books  of  account  containing  entries  relating  to  the 
business  of  such  person,  or  any  other  person  he  may  deem 
proper,  to  appear  before  him  and  produce  such  books  at  a 
time  and  place  named  in  the  summons,  and  to  give  testi- 
mony or  answer  interrogatories,  under  oath,  respecting 
any  objects  or  income  liable  to  tax  or  the  returns  thereof. 
The  collector  may  summon  any  person  residing  or  found 


332  INCOME   AND    FEDERAL    TAX   REPORTS 

within  the  State  or  Territory  in  which  his  district  lies, 
and  when  the  person  intended  to  be  summoned  does  not 
reside  and  can  not  be  found  within  such  State  or  Terri- 
tory, he  may  enter  any  collection  district  where  such 
person  may  be  found  and  there  make  the  examination 
herein  authorized.  And  to  this  end  he  may  there  exer- 
cise all  the  authority  which  he  might  lawfully  exercise 
in  the  district  for  which  he  was  commissioned:  Pro- 
vided, That  "person,"  as  used  in  this  section,  shall 
be  construed  to  include  any  corporation,  joint-stock  com- 
pany or  association,  or  insurance  company  when  such 
construction  is  necessary  to  carry  out  its  provisions." 
"Sec.  3176.  If  any  person,  corporation,  company,  or 
association  fails  to  make  and  file  a  return  or  list  at  the 
time  prescribed  by  law,  or  makes,  wilfully  or  otherwise,  a 
false  or  fraudulent  return  or  list,  the  collector  or  deputy 
collector  shall  make  the  return  or  list  from  his  own 
knowledge  and  from  such  information  as  he  can  obtain 
through  testimony  or  otherwise.  Any  return  or  list  so 
made  and  subscribed  by  a  collector  or  deputy  collector 
shall  be  prima  facie  good  and  sufficient  for  all  legal  pur- 
poses. 

"If  the  failure  to  file  a  return  or  list  is  due  to  sickness 
or  absence  the  collector  may  allow  such  further  time,  not 
exceeding  thirty  days,  for  making  and  filing  the  return 
or  list  as  he  deems  proper. 

"The  Commissioner  of  Internal  Revenue  shall  assess 
all  taxes,  other  than  stamp  taxes,  as  to  which  returns  or 
lists  are  so  made  by  a  collector  or  deputy  collector. 
In  case  of  any  failure  to  make  and  file  a  return  or  list 
within  the  time  prescribed  by  law  or  by  the  collector,  the 
Commissioner  of  Internal  Revenue  shall  add  to  the  tax 
fifty  per  centum  of  its  amount  except  that,  when  a  return 
is  voluntarily  and  without  notice  from  the  collector  filed 
after  such  time  and  it  is  shown  that  the  failure  to  file  it 
was  due  to  a  reasonable  cause  and  not  to  wilful  neglect, 
no  such  addition  shall  be  made  to  the  tax.    In  case  a 


THE    INCOME    TAX    LAW  333 

false  or  fraudulent  return  or  list  is  wilfully  made,  the 
Commissioner  of  Internal  Revenue  shall  add  to  the  tax 
one  hundred  per  centum  of  its  amount. 

"The  amount  so  added  to  any  tax  shall  be  collected  at 
the  same  time  and  in  the  same  manner  and  as  part  of  the 
tax  unless  the  tax  has  been  paid  before  the  discovery  of 
the  neglect,  falsity,  or  fraud,  in  which  case  the  amount  so 
added  shall  be  collected  in  the  same  manner  as  the  tax." 

Sec.  17.  That  it  shall  be  the  duty  of  every  collector  of 
internal  revenue,  to  whom  any  payment  of  any  taxes  is 
made  under  the  provisions  of  this  title,  to  give  to  the  per- 
son making  such  payment  a  full  written  or  printed  re- 
ceipt, expressing  the  amount  paid  and  the  particular  ac- 
count for  which  such  payment  was  made ;  and  whenever 
such  payment  is  made  such  collector  shall,  if  required, 
give  a  separate  receipt  for  each  tax  paid  by  any  debtor, 
on  account  of  payments  made  to  or  to  be  made  by  him  to 
separate  creditors  in  such  form  that  such  debtor  can  con- 
veniently produce  the  same  separately  to  his  several 
creditors  in  satisfaction  of  their  respective  demands  to 
the  amounts  specified  in  such  receipts ;  and  such  receipts 
shall  be  sufficient  evidence  in  favor  of  such  debtor  to 
justify  him  in  withholding  the  amount  therein  expressed 
from  his  next  payment  to  his  creditor ;  but  such  creditor 
may,  upon  giving  to  his  debtor  a  full  written  receipt, 
acknowledging  the  payment  to  him  of  whatever  sum  may 
be  actually  paid,  and  accepting  the  amount  of  tax  paid  as 
aforesaid  (specifying  the  same)  as  a  further  satisfaction 
of  the  debt  to  that  amount,  require  the  surrender  to  him 
of  such  collector's  receipts. 

Sec.  18.  That  any  person,  corporation,  partnership,  as- 
sociation, or  insurance  company,  liable  to  pay  the  tax,  to 
make  a  return  or  to  supply  information  required  under 
this  title,  who  refuses  or  neglects  to  pay  such  tax,  to  make 
such  return  or  to  supply  such  information  at  the  time  or 
times  herein  specified  in  each  year,  shall  be  liable,  except 
as  otherwise  specially  provided  in  this  title,  to  a  penalty 


334  INCOME    AND    FEDERAL    TAX    REPORTS 

of  not  less  than  $20  nor  more  than  $1,000.  Any 
individual  or  any  officer  of  any  corporation,  part- 
nership, association,  or  insurance  company,  required  by 
law  to  make,  render,  sign,  or  verify  any  return  or  to  sup- 
ply any  information,  who  makes  any  false  or  fraudulent 
return  or  statement  with  intent  to  defeat  or  evade  the  as- 
sessment required  by  this  title  to  be  made,  shall  be  guilty 
of  a  misdemeanor,  and  shall  be  fined  not  exceeding  $2,000 
or  be  imprisoned  not  exceeding  one  year,  or  both,  in  the 
discretion  of  the  court,  with  the  costs  of  prosecution ;  Pro- 
vided, That  where  any  tax  heretofore  due  and  payable 
has  been  duly  paid  by  the  taxpayer,  it  shall  not  be  re-col- 
lected from  any  withholding  agent  required  to  retain  it 
at  its  source,  nor  shall  any  penalty  be  imposed  or  col- 
lected in  such  cases  from  the  taxpayer,  or  such  withhold- 
ing agent  whose  duty  it  was  to  retain  it,  for  failure  to  re- 
turn or  pay  the  same,  unless  such  failure  Was  fraudulent 
and  for  the  purpose  of  evading  payment. 

Sec.  19.  The  collector  or  deputy  collector  shall  require 
every  return  to  be  verified  by  the  oath  of  the  party  rend- 
ering  it.  If  the  collector  or  deputy  collector  have  reason 
to  believe  that  the  amount  of  any  income  returned  is 
understated,  he  shall  give  due  notice  to  the  person  making 
the  return  to  show  cause  why  the  amount  of  the  return 
should  not  be  increased,  and  upon  proof  of  the  amount 
understated  may  increase  the  same  accordingly.  Such 
person  may  furnish  sworn  testimony  to  prove  any  rele- 
vant facts,  and,  if  dissatisfied  with  the  decision  of 
the  collector,  may  appeal  to  the  Commissioner  of  In- 
ternal Revenue  for  his  decision  under  such  rules  of  pro 
cedure  as  may  be  prescribed  by  regulation. 

Sec.  20.  That  jurisdiction  is  hereby  conferred  upon  the 
district  courts  of  the  United  States  for  the  district  within 
which  any  person  summoned  under  this  title  to  appear  to 
testify  or  to  produce  books  shall  reside,  to  compel  such 
attendance,  production  of  books,  and  testimony  by  ap- 
propriate process. 


THE    INCOME    TAX    LAW  335 

Sec.  21.  That  the  preparation  and  publication  of  sta- 
tistics reasonably  available  with  respect  to  the  operation 
of  the  income  tax  law  and  containing  classifications  of  tax- 
payers and  of  income,  the  amounts  allowed  as  deductions 
and  exemptions,  and  any  other  facts  deemed  pertinent 
and  valuable,  shall  be  made  annually  by  the  Commis- 
sioner of  Internal  Revenue  with  the  approval  of  the  Sec- 
retary of  the  Treasury. 

Sec.  22.  That  all  administrative,  special,  and  general 
provisions  of  law,  including  the  laws  in  relation  to  the  as- 
sessment, remission,  collection,  and  refund  of  internal 
revenue  taxes  not  heretofore  specifically  repealed  and  not 
inconsistent  with  the  provisions  of  this  title,  are  hereby 
extended  and  made  applicable  to  all  the  provisions  of  this 
title  and  to  the  tax  herein  imposed. 

Sec.  23.  That  the  provisions  of  this  title  shall  extend  to 
Porto  Rico  and  the  Philippine  Islands:  Provided,  That 
the  administration  of  the  law  and  the  collection  of  the 
taxes  imposed  in  Porto  Rico  and  the  Philippine  Islands 
shall  be  by  the  appropriate  internal-revenue  officers  of 
those  governments,  and  all  revenues  collected  in  Porto 
Rico  and  the  Philippine  Islands  thereunder  shall  accrue 
intact  to  the  general  governments  thereof,  respectively: 
Provided  further,  That  the  jurisdiction  in  this  title  con- 
ferred upon  the  district  courts  of  the  United  States  shall, 
so  far  as  the  Philippine  Islands  are  concerned,  be  vested 
in  the  courts  of  the  first  instance  of  said  islands:  And 
provided  further,  That  nothing  in  this  title  shall  be  held 
to  exclude  from  the  computation  of  the  net  income  the 
compensation  paid  any  official  by  the  governments  of  the 
District  of  Columbia,  Porto  Rico,  and  the  Philippine 
Islands,  or  the  political  subdivisions  thereof. 

Sec.  24.  That  Section  II  of  the  Act  approved  October 
third,  nineteen  hundred  and  thirteen,  entitled  "An  Act  to 
reduce  tariff  duties  and  to  provide  revenue  for  the  Gov- 
ernment, and  for  other  purposes,"  is  hereby  repealed,  ex- 
cept as  herein  otherwise  provided,  and  except  that  it 


336  INCOME    AND    FEDERAL    TAX    REPORTS 

shall  remain  in  force  for  the  assessment  and  collection  of 
all  taxes  which  have  accrued  thereunder,  and  for  the  im- 
position and  collection  of  all  penalties  or  forfeitures 
which  have  accrued  or  may  accrue  in  relation  to  any  of 
such  taxes,  and  except  that  the  unexpended  balance  of 
any  appropriation  heretofore  made  and  now  available  for 
the  administration  of  such  section  or  any  provision 
thereof  shall  be  available  for  the  administration  of  this 
title  or  the  corresponding  provision  thereof. 

Sec.  25.  That  income  on  which  has  been  assessed  the 
tax  imposed  by  Section  II  of  the  Act  entitled  "An  Act  to 
reduce  tariff  duties  and  to  provide  revenue  for  the  Gov- 
ernment, and  for  other  purposes,"  approved  October 
third,  nineteen  hundred  and  thirteen,  shall  not  be  consid- 
ered as  income  within  the  meaning  of  this  title :  Provided, 
That  this  section  shall  not  conflict  with  that  portion  of 
section  ten,  of  this  title,  under  which  a  taxpayer  has  fixed 
its  own  fiscal  year. 

Information  to  be  furnished  at  the  source. — Sec.  26.  Every 
corporation,  joint-stock  company  or  association,  or  insur- 
ance company  subject  to  the  tax  herein  imposed,  when 
required  by  the  Commissioner  of  Internal  Eevenue,  shall 
render  a  correct  return,  duly  verified  under  oath,  of  its 
payments  of  dividends,  whether  made  in  cash  or  its 
equivalent  or  in  stock,  including  the  names  and  addresses 
of  stockholders  and  the  number  of  shares  owned  by  each, 
and  the  tax  years  and  the  applicable  amounts  in  which 
such  dividends  were  earned,  in  such  form  and  manner  as 
may  be  prescribed  by  the  Commissioner  of  Internal 
Eevenue,  with  the  approval  of  the  Secretary  of  the 
Treasury. 

Sec.  27.  That  every  person,  corporation,  partnership, 
or  association,  doing  business  as  a  broker  on  any  exchange 
or  board  of  trade  or  other  similar  place  of  business  shall, 
when  required  by  the  Commissioner  of  Internal  Revenue, 
render  a  correct  return  duly  verified  under  oath,  under 
such  rules  and  regulations  as  the  Commissioner  of  Ic- 


THE   IK  COMB    TAX    LAW  337 

ternal  Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  may  prescribe,  showing  the  names  of  customers 
for  whom  such  person,  corporation,  partnership,  or  asso- 
ciation has  transacted  any  business,  with  such  details  as 
to  the  profits,  losses,  or  other  information  which  the  com- 
missioner may  require,  as  to  each  of  such  customers,  as 
will  enable  the  Commissioner  of  Internal  Revenue  to  de- 
termine whether  all  income  tax  due  on  profits  or  gains  of 
such  customers  has  been  paid. 

Sec.  28.  That  all  persons,  corporations,  partnerships, 
associations,  and  insurance  companies,  in  whatever  ca- 
pacity acting,  including  lessees  or  mortgagors  of  real  or 
personal  property,  trustees  acting  in  any  trust  capacity, 
executors,  administrators,  receivers,  conservators,  and 
employers,  making  payment  to  another  person,  corpora- 
tion, partnership,  association,  or  insurance  company,  of 
interest,  rent,  salaries,  wages,  premiums,  annuities,  com- 
pensation, remuneration,  emoluments,  or  other  fixed  or 
determinable  gains,  profits,  and  income  (other  than  pay- 
ments described  in  sections  twenty-six  and  twenty-seven), 
of  $800  or  more  in  any  taxable  year,  or,  in  the  case  of 
such  payments  made  by  the  United  States,  the  officers  or 
employees  of  the  United  States  having  information  as  to 
such  payments  and  required  to  make  returns  in  regard 
thereto  by  the  regulations  hereinafter  provided  for,  are 
hereby  authorized  to  render  a  true  and  accurate  return 
to  the  Commissioner  of  Internal  Revenue,  under  such 
rules  and  regulations  and  in  such  form  and  manner  as 
may  be  prescribed  by  him,  with  the  approval  of  the  Sec- 
retary of  the  Treasury,  setting  forth  the  amount  of  such 
gains,  profits,  and  incomes,  and  the  name  and  address  of 
the  recipient  of  such  payment:  Provided,  That  such  re- 
turns shall  be  required,  regardless  of  amounts,  in  the  case 
of  payments  of  interest  upon  bonds  and  mortgages  or 
deeds  of  trust  or  other  similar  obligations  of  corpora- 
tions, joint-stock  companies,  associations,  and  insurance 
companies,  and  in  the  case  of  collections  of  items  (not 


338  INCOME    AND    FEDERAL    TAX    REPORTS 

payable  in  the  United  States)  of  interest  upon  the  bonds 
of  foreign  countries  and  interest  from  the  bonds  and  divi- 
dends from  the  stock  of  foreign  corporations  by  persons, 
corporations,  partnerships,  or  associations,  undertaking 
as  a  matter  of  business  or  for  profit  the  collection  of  for- 
eign payments  of  such  interest  or  dividends  by  means  of 
coupons,  checks,  or  bills  of  exchange. 

When  necessary  to  make  effective  the  provisions  of  this 
section  the  name  and  address  of  the  recipient  of  income 
shall  be  furnished  upon  demand  of  the  person,  corpora- 
tion, partnership,  association,  or  insurance  company  pay- 
ing the  income. 

The  provisions  of  this  section  shall  apply  to  the  calen- 
dar year  nineteen  hundred  and  seventeen  and  each  calen- 
dar year  thereafter,  but  shall  not  apply  to  the  payment 
of  interest  on  obligations  of  the  United  States. 

Deduction  of  war  excess  profits  tax. — Sec.  29.  That  in  as- 
sessing income  tax  the  net  income  embraced  in  the  return 
shall  also  be  credited  with  the  amount  of  any  excess 
profits  tax  imposed  by  Act  of  Congress  and  assessed  for 
the  same  calendar  or  fiscal  year  upon  the  taxpayer,  and, 
in  the  case  of  a  member  of  a  partnership,  with  his  pro- 
portionate share  of  such  excess  profits  tax  imposed  upon 
the  partnership. 

Exemption  of  income  of  foreign  governments. — Sec.  30. 
That  nothing  in  section  II  of  the  Act  approved  October 
third,  nineteen  hundred  and  thirteen,  entitled  "An  Act  to 
reduce  tariff  duties  and  to  provide  revenue  for  the  Gov- 
ernment, and  for  other  purposes,"  or  in  this  title,  shall 
be  construed  as  taxing  the  income  of  foreign  govern- 
ments received  from  investments  in  the  United  States  in 
stocks,  bonds,  or  other  domestic  securities,  owned  by  such 
foreign  governments,  or  from  interest  on  deposits  in 
banks  in  the  United  States  of  moneys  belonging  to  for- 
eign governments. 

Meaning  of  "dividends"  and  taxation  of  dividends. —  Sec. 
51.  (a)  That  the  term  "dividends"  as  used  in  this  title 


THE    INCOME    TAX    LAW  339 

shall  be  held  to  mean  any  distribution  made  or  ordered  to 
be  made  by  a  corporation,  joint-stock  company,  associa- 
tion, or  insurance  company,  out  of  its  earnings  or  profits 
accrued  since  March  first,  nineteen  hundred  and  thirteen, 
and  payable  to  its  shareholders,  whether  in  cash  or  in 
stock  of  the  corporation,  joint-stock  company,  association, 
or  insurance  company,  which  stock  dividend  shall  be  con- 
sidered income,  to  the  amount  of  the  earnings  or  profits 
so  distributed. 

(b)  Any  distribution  made  to  the  shareholders  or 
members  of  a  corporation,  joint-stock  company,  or  asso- 
ciation, or  insurance  company,  in  the  year  nineteen 
hundred  and  seventeen,  or  subsequent  tax  years,  shall 
be  deemed  to  have  been  made  from  the  most  recently 
accumulated  undivided  profits  or  surplus,  and  shall  con- 
stitute a  part  of  the  annual  income  of  the  distributee 
for  the  year  in  which  received,  and  shall  be  taxed  to  the 
distributee  at  the  rates  prescribed  by  law  for  the  years 
in  which  such  profits  or  surplus  were  accumulated  by 
the  corporation,  joint-stock  company,  association,  or 
insurance  company,  but  nothing  herein  shall  be  con- 
strued as  taxing  any  earnings  or  profits  accrued  prior 
to  March  first,  nineteen  hundred  and  thirteen,  but  such 
earnings  or  profits  may  be  distributed  in  stock  dividends 
or  otherwise,  exempt  from  the  tax,  after  the  distribution 
of  earnings  and  profits  accrued  since  March  first,  nine- 
teen hundred  and  thirteen,  has  been  made. 

This  subdivision  shall  not  apply  to  any  distribution 
made  prior  to  August  sixth,  nineteen  hundred  and 
seventeen,  out  of  earnings  or  profits  accrued  prior  to 
March  first,  nineteen  hundred  and  thirteen. 

Premiums  on  "business"  life  insurance  not  deductible. — 
Sec.  32.  That  premiums  paid  on  life  insurance  policies 
covering  the  lives  of  officers,  employees,  or  those  finan- 
cially interested  in  any  trade  or  business  conducted  by 
an  individual,  partnership,  corporation,  joint-stock  com- 
pany or  association,  or  insurance  company,   shall  not 


340  INCOME    AND  FEDERAL    TAX   REPORTS 

be  deducted  in  computing  the  net  income  of  such  indi- 
vidual, corporation,  joint-stock  company  or  association, 
or  insurance  company,  or  in  computing  the  profits  of 
such  partnership  for  the  purposes  of  subdivision  (e) 
of  section  eight. 

Refund  of  tax  withheld  at  the  source  in  1907. — Sec.  1212 
[of  Title  XII.— "Income  Tax  Amendments"  of  Act  of 
October  3,  1917].  That  any  amount  heretofore  withheld 
by  any  withholding  agent  as  required  by  Title  I  of  such 
Act  of  September  eighth,  nineteen  hundred  and  sixteen, 
on  account  of  the  tax  imposed  upon  the  income  of  any 
individual,  a  citizen  or  resident  of  the  United  States, 
for  the  calendar  year  nineteen  hundred  and  seventeen, 
except  in  the  cases  covered  by  subdivision  (c)  of  sec- 
tion nine  of  such  Act,  as  amended  by  this  Act,  shall  be 
released  and  paid  over  to  such  individual,  and  the  entire 
tax  upon  the  income  of  such  individual  for  such  year 
shall  be  assessed  and  collected  in  the  manner  prescribed 
by  such  Act  as  amended  by  this  Act. 

Act  of  September  8,  1916,  in  effect  September  9,  1916. 

Effective  date  of  Act  as  amended,  October  4,  1917. 


CHAPTER  XIII—  (Continued) 

THE  WAR  INCOME  TAX  AFFECT 

ING  INDIVIDUALS  AND 

COPORATIONS 

TITLE  I  OF  THE  ACT  OF  OCTOBER  3,   1917 
(PUBLIC— No.   50— 65th  Congress) 


TITLE   I— WAR   INCOME    TAX 

Individual  normal  war  tax  rate. — Sec.  1.  That  in  addi 
tion  to  the  normal  tax  imposed  by  subdivision  (a)  of 
section  one  of  the  Act  entitled  "An  Act  to  increase  the 
revenue,  and  for  other  purposes,"  approved  September 
eighth,  nineteen  hundred  and  sixteen,  there  shall  be 
levied,  assessed,  collected,  and  paid  a  like  normal  tax 
of  two  per  centum  upon  the  income  of  every  individual, 
a  citizen  or  resident  of  the  United  States,  received  in 
the  calendar  year  nineteen  hundred  and  seventeen  and 
every  calendar  year  thereafter. 

Individual  additional  war  tax  rate. — Sec.  2.  That  in 
addition  to  the  additional  tax  imposed  by  subdivision 
(b)  of  section  one  of  such  Act  of  September  eighth, 
nineteen  hundred  and  sixteen,  there  shall  be  levied, 
assessed,  collected,  and  paid  a  like  additional  tax  upon 
the  income  of  every  individual  received  in  the  calendar 
year  nineteen  hundred  and  seventeen  and  every  calendar 
year  thereafter,  as  follows: 

One  per  centum  per  annum  upon  the  amount  by  which 
the  total  net  income  exceeds  $5,000  and  does  not  exceed 
$7,500; 

341 


342  INCOME    AND    FEDERAL    TAX    REPORTS 

Two  per  centum  per  annum  upon  the  amount  by  which 
the  total  net  income  exceeds  $7,500  and  does  not  exceed 
$10,000; 

Three  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $10,000  and  does  not 
exceed  $12,500; 

Four  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $12,500  and  does  not 
exceed  $15,000; 

Five  per  centum  per  annum  upon  the  amount  by  which 
the  total  net  income  exceeds  $15,000  and  does  not  ex- 
ceed $20,000; 

Seven  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $20,000  and  does  not 
exceed  $40,000; 

Ten  per  centum  per  annum  upon  the  amount  by  which 
the  total  net  income  exceeds  $40,000  and  does  not  exceed 
$60,000; 

Fourteen  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $60,000  and  does  not 
exceed  $80,000; 

Eighteen  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $80,000  and  does  not 
exceed  $100,000; 

Twenty-two  per  centum  per  annum  upon  the  amount 
by  which  the  total  net  income  exceeds  $100,000  and  does 
not  exceed  $150,000; 

Twenty-five  per  centum  per  annum  upon  the  amount 
by  which  the  total  net  income  exceeds  $150,000  and  does 
not  exceed  $200,000; 

Thirty  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $200,000  and  does 
not  exceed  $250,000; 

Thirty-four  per  centum  per  annum  upon  the  amount 
by  which  the  total  net  income  exceeds  $250,000  and  does 
not  exceed  $300,000; 

Thirty-seven  per  centum  per  annum  upon  the  amount 


THE    WAR    INCOME    TAX  343 

by  which  the  total  net  income  exceeds  $300,000  and  does 
not  exceed  $500,000; 

Forty  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $500,000  and  does 
not  exceed  $750,000; 

Forty-five  per  centum  per  annum  upon  the  amount 
by  which  the  total  net  income  exceeds  $750,000  and  does 
not  exceed  $1,000,000; 

Fifty  per  centum  per  annum  upon  the  amount  by 
which  the  total  net  income  exceeds  $1,000,000. 

Specific  exemptions  from  normal  war  tax. — Sec.  3.  That 
the  taxes  imposed  by  sections  one  and  two  of  this  Act 
shall  be  computed,  levied,  assessed,  collected,  and  paid 
upon  the  same  basis  and  in  the  same  manner  as  the  sim- 
ilar taxes  imposed  by  section  one  of  such  Act  of  Sep- 
tember eighth,  nineteen  hundred  and  sixteen,  except 
that  in  the  case  of  the  tax  imposed  by  section  one  of 
this  Act 

(a)  the  exemptions  of  $3,000  and  $4,000  provided  in 
section  seven  of  such  Act  of  September  eighth,  nineteen 
hundred  and  sixteen,  as  amended  by  this  Act,  shall  be, 
respectively,  $1,000  and  $2,000,  and 

(b)  the  returns  required  under  subdivisions  (b)  and 
(c)  of  section  eight  of  such  Act,  as  amended  by  this  Act, 
shall  be  required  in  the  case  of  net  incomes  of  $1,000 
or  over,  in  the  case  of  unmarried  persons,  and  $2,000 
or  over  in  the  case  of  married  persons,  instead  of  $3,000 
or  over,  as  therein  provided,  and 

(c)  the  provisions  of  subdivision  (c)  of  section  nine 
of  such  Act,  as  amended  by  this  Act,  requiring  the  nor- 
mal tax  of  individuals  on  income  derived  from  interest 
to  be  deducted  and  withheld  at  the  source  of  the  income 
shall  not  apply  to  the  new  two  per  centum  normal  tax 
prescribed  in  section  one  of  this  Act  until  on  and  after 
January  first,  nineteen  hundred  and  eighteen,  and  there- 
after only   one   two   per   centum  normal   tax   shall  be 


344  INCOME    AND    FEDERAL    TAX    REPORTS 

deducted  and  withheld  at  the  source  under  the  provi- 
sions of  such  subdivision  (c),  and  any  further  normal 
tax  for  which  the  recipient  of  such  income  is  liable  under 
this  Act  or  such  Act  of  September  eighth,  nineteen  hun- 
dred and  sixteen,  as  amended  by  this  Act,  shall  be  paid 
by  such  recipient. 

Corporation  war  income  tax. — Sec.  4.  That  in  addition 
to  the  tax  imposed  by  subdivision  (a)  of  section  ten  of 
such  Act  of  September  eighth,  nineteen  hundred  and 
sixteen,  as  amended  by  this  Act,  there  shall  be  levied, 
assessed,  collected,  and  paid  a  like  tax  of  four  per 
centum  upon  the  income  received  in  the  calendar  year 
nineteen  hundred  and  seventeen  and  every  calendar  year 
thereafter,  by  every  corporation,  joint-stock  company  or 
association,  or  insurance  company,  subject  to  the  tax 
imposed  by  that  subdivision  of  that  section,  except  that 
if  it  has  fixed  its  own  fiscal  year,  the  tax  imposed  by 
this  section  for  the  fiscal  year  ending  during  the  calen- 
dar year  nineteen  hundred  and  seventeen  shall  be  levied^ 
assessed,  collected,  and  paid  only  on  that  proportion  of 
its  income  for  such  fiscal  year  which  the  period  between 
January  first,  nineteen  hundred  and  seventeen,  and  the 
end  of  such  fiscal  year  bears  to  the  whole  of  such  fiscal 
year. 

The  tax  imposed  by  this  section  shall  be  computed, 
levied,  assessed,  collected,  and  paid  upon  the  same  in- 
comes and  in  the  same  manner  as  the  tax  imposed  by 
subdivision  (a)  of  section  ten  of  such  Act  of  September 
eighth,  nineteen  hundred  and  sixteen,  as  amended  by 
this  Act,  except  that  for  the  purpose  of  the  tax  imposed 
by  this  section  the  income  embraced  in  a  return  of  a 
corporation,  joint-stock  company  or  association,  or  in- 
surance company,  shall  be  credited  with  the  amount 
received  as  dividends  upon  the  stock  or  from  the  net 
earnings  of  any  other  corporation,  joint-stock  company 
or  association,  or  insurance  company,  which  is  taxable 
upon  its  net  income  as  provided  in  this  title. 


THE    WAR   INCOME   TAX  345 

Porto  Rico  and  the  Philippine  Islands  not  affected. — 
Sec.  5.  That  the  provisions  of  this  title  shall  not  extend 
to  Porto  Rico  or  the  Philippine  Islands,  and  the  Porto 
Rican  or  Philippine  Legislature  shall  have  power  by- 
due  enactment  to  amend,  alter,  modify,  or  repeal  the 
income  tax  laws  in  force  in  Porto  Rico  or  the  Philippine 
Islands,  respectively. 

In  effect  October  4,  1917. 

TITLE    X.— ADMINISTRATIVE    PROVISIONS    OF    THE 
ACT    OF    OCTOBER   3,    1917 

(Public— No.  50— 65th  Congress) 

[Effective  October  4,  1917] 

Prepayment  of  taxes. — Sec.  1009  [of  Title  X. — Admin- 
istrative Provisions  of  the  Revenue  Act  of  October  3, 
1917].  That  the  Secretary  of  the  Treasury,  under  rules 
and  regulations  prescribed  by  him,  shall  permit  tax- 
payers liable  to  income  and  excess  profits  taxes  to  make 
payments  in  advance  in  installments  or  in  whole  of  an 
amount  not  in  excess  of  the  estimated  taxes  which  will 
be  due  from  them,  and  upon  determination  of  the  taxes 
actually  due  any  amount  paid  in  excess  shall  be  re- 
funded as  taxes  erroneously  collected: 

Provided,  That  when  payment  is  made  in  installments 
at  least  one-fourth  of  such  estimated  tax  shall  be  paid 
before  the  expiration  of  thirty  days  after  the  close  of 
the  taxable  year,  at  least  an  additional  one-fourth 
within  two  months  after  the  close  of  the  taxable  year, 
at  least  an  additional  one-fourth  within  four  months 
after  the  close  of  the  taxable  year,  and  the  remainder 
of  the  tax  due  on  or  before  the  time  now  fixed  by  law 
for  such  payment: 

Provided  further,  That  the  Secretary  of  the  Treas- 
ury, under  rules  and  regulations  prescribed  by  him,  may 
allow  credit  against  such  taxes  so  paid  in  advance  of 


346  INCOME    AND    FEDERAL    TAX    REPORTS 

an  amount  not  exceeding  three  per  centum  per  annum 
calculated  upon  the  amount  so  paid  from  the  date  of 
such  payment  to  the  date  now  fixed  by  law  for  such 
payment;  but  no  such  credit  shall  be  allowed  on  pay- 
ments in  excess  of  taxes  determined  to  be  due,  nor  on 
payments  made  after  the  expiration  of  four  and  one- 
half  months  after  the  close  of  the  taxable  year. 

All  penalties  provided  by  existing  law  for  failure  to 
pay  tax  when  due  are  hereby  made  applicable  to  any 
failure  to  pay  the  tax  at  the  time  or  times  required  in 
this  section. 

Payment  of  tax  with  Treasury  certificates  and  uncertified 
checks. — Sec.  1010.  That  under  rules  and  regulations 
prescribed  by  the  Secretary  of  the  Treasury,  Collectors 
of  Internal  Eevenue  may  receive,  at  par  and  accrued 
interest,  certificates  of  indebtedness  issued  under  sec- 
tion six  of  the  Act  entitled  "An  Act  to  authorize  an 
issue  of  bonds  to  meet  expenditures  for  the  national 
security  and  defense,  and,  for  the  purpose  of  assisting 
in  the  prosecution  of  the  war,  to  extend  credit  to  for- 
eign governments,  and  for  other  purposes,"  approved 
April  twenty-fourth,  nineteen  hundred  and  seventeen, 
and  any  subsequent  Act  or  Acts,  and  uncertified  checks 
in  payment  of  income  and  excess  profits  taxes,  during 
such  time  and  under  such  regulations  as  the  Commis- 
sioner of  Internal  Eevenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  shall  prescribe;  but  if  a 
check  so  received  is  not  paid  by  the  bank  on  which  it 
is  drawn  the  person  by  whom  such  check  has  been  ten- 
dered shall  remain  liable  for  the  payment  of  the  tax 
and  for  all  legal  penalties  and  additions  the  same  as  if 
such  check  had  not  been  tendered. 


CHAPTER  XIV 
CAPITAL  STOCK  TAX 

History  of  capital  stock  tax. — The  law  of  September  8, 
1916,  under  Title  IV.,  Section  407,  imposes  an  excise1  tax 
on  every  domestic  corporation  the  fair  value  of  whose 
total  outstanding  capital  stock  exceeds  $99,000  and  on 
every  foreign  corporation  engaged  in  business  in  this 
country.  This  excise  tax,  or  as  it  is  frequently  called, 
the  capital  stock  tax,  was  substituted  for  the  special  tax 
on  bankers  imposed  under  the  Emergency  Revenue  Law 
of  October  22,  1914.  The  distinction  between  the  two  is 
that  the  old  law  was  a  tax  on  every  person,  firm,  or  cor- 
poration engaged  in  banking,  while  the  new  law  taxes 
every  corporation,  whether  engaged  in  banking  or  any 
other  business. 

This  tax  is  an  excise  tax  on  the  privilege  of  doing 
business,  and  is  similar  to  the  occupational  taxes  im- 
posed on  individuals  except  that,  instead  of  being  a  flat 
tax,  the  amount  of  the  tax  is  measured  by  the  average 
value  of  the  stock  during  the  preceding  year. 

Being  a  privilege  or  occupational  tax,  it  is  payable 
in  advance  annually  in  July,  which  is  the  beginning  of 
the  Government's  fiscal  year. 

This  law  went  into  effect  January  1,  1917,  and  the 
first  tax  collected  was  for  the  privilege  of  doing  busi- 
ness for  the  half  year  from  January  1,  1917,  to  June 
30,  1917.  The  second  tax  was  collected  in  July,  1917, 
and  was  for  the  privilege  of  doing  business  for  the  en- 

i  "Excise"  is  defined  to  be  an  inland  imposition,  sometimes  upon  the  con- 
sumption of  the  commodity  and  sometimes  upon  retail  sale,  sometimes  upon 
the  manufacturer  and  sometimes  upon  the  vendor.     (22  Cyc.  1598.) 

347 


348  INCOME    AND    FEDERAL    TAX    REPORTS 

suing  taxable  year  ending  June  30,  1918.  The  tax  is 
therefore  payable  every  July  for  the  privilege  of  doing 
business  for  the  taxable  year  ending  the  following  June 
30th. 

Capital  Stock  Tax  independent  of  other  taxes. — The 
Capital  Stock  Tax  has  no  connection  with  the  Income 
Tax,  the  War  Excess  Profits  Tax,  or  with  State  capital 
stock  taxes.  It  is  an  entirely  separate  and  distinct  tax. 
Keports  for  this  tax  are  required  to  be  made  out  on  a 
separate  form  and  filed  at  a  different  time  from  that  of 
the  filing  of  returns  for  any  other  tax. 

Deduction  of  Munitions  Tax. — The  amount  of  tax  paid 
under  Section  301  of  Title  III  of  the  act  of  September 
8,  1916  (Munitions  Manufacturer's  Tax)  since  the  filing 
of  the  last  previous  report  may  be  deducted  in  comput- 
ing the  Capital  Stock  Tax.1 

What  United  States  corporations  are  subject  to  tax. — 
Every  corporation,  joint  stock  company  or  association, 
or  insurance  company,  organized  in  the  United  States 
for  profit,  and  having  a  capital  stock  represented  by 
shares  the  fair  value  of  which  is  in  excess  of  $99,000, 
which  was  engaged  in  business  during  the  preceding  fis- 
cal year,  is  subject  to  this  tax  unless  specially  exempted 
by  the  Act. 

While  the  tax  does  not  accrue  except  in  cases  where 
the  valuation  of  the  capital  stock  exceeds  $99,000,  a  re- 
turn must  be  filed  in  the  case  of  a  corporation  the  mar- 
ket value  of  whose  capital  stock  outstanding  is  $75,000 
or  more. 

Foreign  corporations  subject  to  tax. — Every  corpora- 
tion, joint  stock  company  or  association,  or  insurance 
company  organized  for  profit  under  the  laws  of  any 
foreign  country  and  engaged  in  business  in  the  United 

i  Credit  cannot  be  had  on  capital  stock  tax  return  for  1917  for  muni- 
tions tax  paid  in  1917,  but  as  to  whether  such  credit  can  be  had  against 
subsequent  capital  stock  tax  returns,  in  cases  where  the  munitions  tax  is 
in  excess  of  the  capital  stock  tax  paid,  is  a  question  not  yet  passed  on  by 
the  Department,  but  which  will  be  if  it  should  arise. 


CAPITAL    STOCK   TAX  349 

States  is  subject  to  the  tax  on  the  value  of  the  capital 
actually  invested  in  the  transaction  of  business  in  the 
United  States.  If  the  corporation  makes  a  return  show- 
ing the  total  amount  of  capital  invested  in  the  transac- 
tion of  business  both  abroad  and  in  this  country  it  may 
deduct  from  the  value  of  the  capital  invested  in  the 
United  States  such  proportion  of  $99,000  as  the 
amount  invested  in  the  United  States  bears  to  the  total 
amount  invested  in  the  United  States  and  elsewhere. 
To  illustrate,  a  foreign  corporation  has  $100,000  actu- 
ally invested  in  the  United  States.  Its  total  capital 
invested  (including  that  invested  in  the  United  States) 
is  $1,000,000.  It  will  be  allowed  as  a  deduction  10$ 
(100,000 -f- 1,000,000)   of  $99,000,  or  $9,900. 

Corporations  need  not  have  been  in  business  during  the 
entire  preceding  year. — It  is  not  necessary  that  the  cor- 
poration, to  be  liable,  must  have  been  engaged  in  busi- 
ness during  the  entire  year  ended  June  30th.  It  is  suffi- 
cient that  the  corporation  was  engaged  in  business  at 
some  time  during  the  year.  The  length  of  time  it  was 
engaged  in  business  has  no  bearing  upon  the  amount  of 
the  tax  to  be  paid. 

Inactive  corporations  need  not  pay  tax. — Corporations 
which  were  engaged  in  business  at  some  time  during 
the  preceding  fiscal  year  but  which  were  not  engaged 
in  business  at  the  time  a  return  was  due  (i.  e.,  July 
1st  to  30th,  inclusive),  are  not  required  to  file  a  return, 
but  should  they  subsequently  resume  business  they  must 
file  a  return  in  the  month  in  which  they  resume  business. 

Returns  required  of  United  States  corporations. — Eegu- 
lation  Number  38,  of  the  Treasury  Department,  pro- 
vides that:  "Every  corporation,  joint  stock  company  or 
association,  or  insurance  company  organized  in  the 
United  States  for  profit  and  having  a  capital  stock  is- 
sued and  outstanding  of  the  market  value  of  $75,000 
or  over  and  not  exempt  by  the  act,  shall  make  a  return 
on  Form  707  irrespective  of  the  par  value  of  its  capital 


350  INCOME   AND    FEDERAL    TAX   REPORTS 

stock,  unless  such  corporation,  joint  stock  company  or 
association,  or  insurance  company  was  not  engaged  in 
business  during  the  preceding  taxable  year." 

The  phrase  "of  the  market  value  of  $75,000"  as  used 
in  this  decision  should  be  held  as  meaning  "of  the  fair 
value  of  $75,000."  The  tax  is  based  upon  the  "fair 
value"  of  the  stock.  While  the  Treasury  Department 
recognizes  that  the  market  value  is  the  fair  value  where 
the  market  value  can  be  obtained,  it  also  provides  a 
method  of  determining  the  fair  value  in  cases  where 
there  is  no  basis  from  which  to  obtain  the  market  value. 

Returns  will  therefore  be  required  of  all  corporations 
the  fair  value  of  whose  stock  is  $75,000  or  more,  re- 
gardless of  whether  or  not  a  market  value  has  been 
established. 

Returns  required  of  every  foreign  corporation. — "Every 
corporation,  joint  stock  company  or  association  or  in- 
surance company,  organized  for  profit  under  the  laws 
of  any  foreign  country  and  engaged  in  business  in  the 
United  States,  shall  make  return  on  Form  708  irrespec- 
tive of  the  amount  of  capital  employed  either  at  home 
or  in  this  country  in  the  transaction  of  its  business." 
(T.  D.  Reg.  38.)  * 

Returns  required  from  holding  companies. — The  filing  of 
returns  by  its  subsidiary  companies  does  not  relieve  a 
holding  company  from  its  liability  to  the  tax  or  from 
filing  its  own  return. 

Corporations  exempt. — Section  407  of  this  Act  exempts 
from  the  Capital  Stock  Tax  all  corporations  which  are 
exempt  from  the  Income  Tax  under  the  provisions  of 
section  11,  Title  I.  For  a  list  of  such  exempt  classes 
of  corporations,  joint  stock  companies  or  associations, 
and  insurance  companies,  see  Chapter  VII. 

Although  labor,  agricultural  or  horticultural  associa- 
tions are  exempt  under  the  section  referred  to,  this  ex- 
emption does  not  include  corporations  engaged  in  general 
farming,  raising  cattle,  or  agricultural  business  for  profit. 


CAPITAL    STOCK    TAX  351 

Mutual  companies  exempt. — Inasmuch  as  the  basis  of 
the  tax  is  the  fair  value  of  the  stock  of  a  corporation, 
mutual  insurance  companies  and  other  associations  not 
having  capital  represented  by  shares  will  also  be  ex- 
empt from  the  tax  because  of  the  absence  of  a  basis 
for  the  computation  of  the  tax. 

Massachusetts,  or  Common  Law  Trusts,  exempt. — Massa- 
chusetts trusts,  the  so-called  Common  Law  trusts,  were 
held  to  be  exempt  from  the  Corporation  Tax  of  1909, 
under  the  decision  in  the  case  of  Eliot  vs.  Freeman 
et  al.  (220  U.  S.  178).  In  T.  D.  2418,  the  Treasury  De- 
partment stated  that  the  ruling  would  be  held  to  cover 
the  Capital  Stock  Tax. 

The  court  stated  as  follows:  "The  two  cases  under 
consideration  embrace  trusts  which  do  not  derive  any 
benefit  from  and  are  not  organized  under  the  statutory 
laws  of  Massachusetts.  Joint  stock  companies  of  the 
statutory  character  are  not  known  to  the  laws  of  that 
Commonwealth.  These  trusts  do  not  have  perpetual 
succession  but  end  with  lives  in  being  and  20  years 
thereafter. 

"Entertaining  the  view  that  it  was  the  intention  of 
Congress  to  embrace  within  the  Corporation  Tax 
statutes  only  such  corporations  and  joint  stock  asso- 
ciations as  are  organized  under  some  statute  or  derive 
from  that  source  some  quality  or  benefit  not  existing  at 
the  common  law,  we  are  of  the  opinion  that  the  real 
estate  trusts  involved  in  these  two  cases  are  not  within 
the  terms  of  the  Act." 

Domestic  Building  and  Loan  Associations  organized  and 
operated  for  mutual  purposes  and  without  profit  are  exempt. 
— The  words  "no  part  of  the  net  income  of  which  inures 
to  the  benefit  of  any  private  stockholder  or  individual" 
does  not  apply  to  domestic  building  and  loan  associa- 
tions operated  for  the  mutual  benefit  of  members.  See 
Herold,  Collector,  vs.  Park  View  B.  &  L.  Ass'n.  (210 
Fed.  577). 


352  INCOME    AND    FEDERAL    TAX    REPORTS 

Corporations  in  the  hands  of  receivers  exempt. — Cor- 
porations which  were  in  the  hands  of  receivers  at  the 
due  time  of  filing  returns  would  not  be  required  to  make 
a  return  unless  the  receivership  terminated  before  the 
close  of  the  taxable  period. 

If  the  operation  of  the  corporation  were  then  re- 
sumed under  corporate  management,  a  return  on  Form 
707  must  be  filed  during  the  month  in  which  operation 
was  resumed.  The  tax  would  be  computed  propor- 
tionately from  the  first  day  of  the  month  in  which  it 
resumes  business  to  the  end  of  the  fiscal  year. 

Corporations  operating  under  their  corporate  man- 
agement but  which  were  in  the  hands  of  receivers  dur- 
ing the  preceding  fiscal  year  (July  1,  1916,  to  June  30, 
1917),  would  not  be  required  to  file  return  during  July, 
1917,  for  the  period  ending  June  30,  1918. 

Corporations  not  engaged  in  business  during  preceding 
taxable  year  are  exempt. — The  last  part  of  Section  407, 
Title  IV,  reads:  "This  tax  shall  not  be  imposed  upon 
any  corporation,  joint  stock  company  or  association,  or 
insurance  company  not  engaged  in  business  during  the 
preceding  taxable  year." 

When  is  a  corporation  not  engaged  in  business. — The 
tax  is  an  excise  tax  imposed  on  corporations.  It  is  not 
imposed  on  the  franchise  of  the  corporation  irrespec- 
tive of  its  use  in  business,  nor  upon  the  property  of 
the  corporation,  but  it  is  imposed  on  the  doing  of  cor- 
porate business  and  for  the  privilege  of  doing  business. 

The  simple  fact  of  holding  a  franchise  does  not  make 
a  corporation  liable  to  the  tax.  It  is  necessary  that  a 
corporation  do  certain  acts  so  that  it  may  be  held  as 
engaged  in  business.  The  question  of  what  degree  of 
activity  is  necessary  in  order  that  a  corporation  be  so 
held  has  been  somewhat  complicated  by  the  varying 
views  of  the  several  court  decisions  rendered. 

The  Corporation  Tax  Law  of  1909  levied  a  tax  upon 
the  net  income  of  corporations  "engaged  in  business." 


CAPITAL    STOCK    TAX  353 

Quite  naturally  the  question  arose  as  to  the  meaning  of 
the  term  "engaged  in  business."  A  number  of  cases 
were  decided  in  the  Supreme  Court  and  in  the  District 
courts  defining  the  term. 

Treasury  Decision  2418,  of  December  15,  1916,  re- 
lating to  this  point,  is  as  follows: 

"The  following  decisions,  made  in  cases  arising  un- 
der the  corporation  tax  act  of  August  5,  1909,  will  be 
followed  where  they  are  final  or  have  been  acquiesced 
in  by  the  Department  in  similar  questions  arising  un- 
der the  special  excise  tax  imposed  by  section  407,  Title 
IV,  Act  of  September  8,  1916." 

Next  followed  the  decisions  in  a  number  of  Supreme 
Court  cases,  and  also  a  list  of  a  number  of  cases  de- 
cided in  the  lower  courts,  ending  with  the  statement: 

"Corporations  which  are  not  'engaged  in  business'  or 
'transacting  business'  as  construed  under  the  language 
of  the  courts  in  the  above  decisions  are  not  subject  to 
the  special  excise  tax  imposed  under  section  407  of 
the  act  of  September  8,  1916." 

Among  the  cases  cited  was  the  case  of  United  States 
vs.  Nippissing  Mines  Company  (206  Fed.  431),  in  which 
it  was  held  that  a  corporation  owning  the  stock  of  a 
number  of  subsidiary  companies  receiving  dividends  on 
the  stocks  and  distributing  said  dividends  to  its  own 
stockholders  was  not  engaged  in  business.  When  the 
first  returns  were  due,  in  January,  1917,  a  number  of 
corporations  claimed  exemption  under  this  decision,  and 
in  answer  to  these  claims  the  Treasury  Department,  in 
T.  D.  2429,  of  January  4,  1917,  stated  as  follows: 

"In  reply  you  are  advised  that  this  office  has  never 
acquiesced  in  the  decision  of  the  court  in  the  case  of 
United  States  vs.  Nippissing  Mines  Company,  and  the 
question  of  whether  a  corporation  organized  for  the 
purpose  of  acquiring  and  holding  all  the  capital  stock 
of  subsidiaries,  and  actually  engaged  in  holding  such 
stock,  voting  thereon,  receiving  dividends  when  paid  by 


354        INCOME    AND    FEDERAL    TAX    REPORTS 

the  subsidiaries,  keeping  books,  and  paying  out  money 
to  its  own  shareholders,  is  now  doing  business  within 
the  meaning  of  the  Corporation  Tax  Act  of  August  5, 
1909,  is  now  pending  in  the  Circuit  Court  of  Appeals 
for  the  Southern  District  of  New  York. 

"This  office  is  of  the  opinion,  therefore,  that  a  'hold- 
ing company'  organized  in  the  United  States  for  the 
purpose  of  acquiring  and  holding  capital  stock  of  sub- 
sidiary companies  and  actually  engaged  in  holding  such 
stock,  voting  thereon,  and  distributing  money  among  its 
own  shareholders,  is  engaged  in  business  within  the 
meaning  of  the  Act  of  September  8,  1916,  and  is  sub- 
ject to  the  special  tax  imposed  under  section  407.  A 
ruling  to  this  effect  will  be  published  in  the  weekly  edi- 
tion of  Treasury  Decisions,  and  will  be  followed  by  the 
Department  until  the  Supreme  Court  decides  to  the 
contrary." 

On  January  15,  1917,  the  Supreme  Court  issued  its 
decision  in  the  case  of  Baumbach  vs.  Sargent  Realty 
Company. 

(T.  D.  2436.    Dated  January  19,  1917.    In  part  only.) 

( Decision. ) 

Corporation  Excise  Tax  Law  of  1909. 

SUPREME    COURT    OF   THE    UNITED    STATES. 

Fred  Von  Baumbach,  Collector  of  Internal ' 

Revenue,  Petitioner, 

vs. 

Sargent  Land  Company. 


Writs  of  Certiorari  to  the 
United  States  Circuit 
Court  of  Appeals  for 
the  Eighth  Circuit. 


Same, 

vs. 

Sutton  Land  Company. 

Same, 

vs. 

Kearsarge  Land  Company. 

[January  15,  1917.] 
Mr.  Justice  Day  delivered  the  opinion  of  the  Court. 


CAPITAL    STOCK    TAX  355 


STATEMENT   OF    FACTS. 

These  three  cases  were  argued  and  submitted  together  and  involve 
practically  the  same  facts.  Suits  were  brought  by  the  corporations  named 
in  the  United  States  District  Court  for  the  District  of  Minnesota  against 
the  Collector  of  Internal  Revenue,  to  recover  certain  taxes,  paid  under 
protest,  assessed  under  the  Corporation  Tax  Law  of  1909  (36  Stat.  11, 
112),  for  the  years  1909,  1910  and  1911.  The  judgments  in  the  District 
Court  were  for  the  respondents  (207  Fed.  423)  which  judgments  were 
affirmed  in  the  Circuit  Court  of  Appeals  (219  Fed.  31). 

In  1890,  John  S.  Pillsbury,  George  A.  Pillsbury  and  Charles  A.  Pills- 
bury,  doing  business  together  as  John  S.  Pillsbury  &  Company,  were  the 
owners  of  large  tracts  of  lands  in  northern  Minnesota,  which  nad  been 
acquired  for  the  timber  and  from  which  the  timber  had  been  cut,  being 
valuable  after  such  severance  of  the  timber  for  the  mineral  deposits  con- 
tained therein.  In  the  year  named,  the  Pillsburys  entered  into  an  arrange- 
ment with  John  M.  Longyear  and  Russell  M.  Bennett,  authorizing  the 
latter  two  to  explore  the  lands  for  iron  deposits.  In  1892,  Longyear  and 
Bennett  having  discovered  valuable  deposits  of  iron  ore,  a  half  interest 
in  something  over  ten  thousand  acres  of  the  lands  was  conveyed  to  them, 
the  lands  thereafter  being  owned  by  the  Pillsburys,  John,  George  and 
Charles,  each  an  undivided  sixth,  and  John  M.  Longyear  and  Russell  M. 
Bennett  each  an  undivided  fourth.  In  the  year  1901,  the  Pillsburys  having 
died,  these  corporations  were  formed  under  the  laws  of  Minnesota.  In 
1906,  the  ownership  of  these  leased  lands  was  vested  in  the  three  corpora- 
tions named  as  respondents  in  the  proceedings.  As  originally  organized, 
the  nature  of  the  business  was  stated  to  be  "the  buying,  owning,  exploring 
and  developing,  leasing,  improving,  selling  and  dealing  in  lands,  tenements 
and  hereditaments,  and  the  doing  of  all  things  incidental  to  the  things 
above  specified."  In  December,  1909,  the  articles  of  incorporation  were 
amended  to  read  as  follows:  "The  general  purpose  of  the  corporation  is 
to  unite  in  one  ownership  the  undivided,  fractional  interest  of  its  various 
stockholders  in  lands,  tenements  and  hereditaments,  and  to  own  such 
property,  and,  for  the  convenience  of  its  stockholders,  to  receive  and  dis- 
tribute to  them  the  proceeds  of  any  disposition  of  such  property,  at  such 
times,  in  such  amounts,  and  in  such  manner  as  the  Board  of  Directors  may 
determine." 

All  of  the  mining  leases,  hereinafter  mentioned,  with  the  exception  of 
a  contract  with  the  Van  Buren  Mining  Company,  were  executed  before  the 
organization  of  the  corporations.  Each  of  these  instruments  provided  that 
the  owners  of  the  property  demised  to  the  lessees,  exclusively,  all  the  lands 
covered  by  the  descriptions  for  the  purpose  of  exploring  for,  mining  and 
removing  the  merchantable  iron  ore  which  might  be  found  therein  for  and 
during  the  period  named,  usually  fifty  years.  The  lessees  were  given  ex- 
clusive right  to  occupy  and  control,  the  demised  premises  and  to  erect  all 
necessary  buildings,  structures  and  improvements  thereon.  Right  was 
reserved  to  the  lessors  to  enter  for  the  purpose  of  measuring  the  amount 


356  INCOME   AND    FEDERAL    TAX   REPORTS 

of  ore  mined  and  removed  and  making  observations  of  the  operations  in 
the  mines.  The  lessees  agreed  to  pay,  in  most  cases,  twenty-five  cents  per 
ton  for  all  ore  mined  and  removed,  and  to  make  such  payments  monthly 
for  ore  mined  and  shipped  during  the  preceding  month.  The  lessees  agreed 
to  mine  and  ship  a  specified  quantity  of  ore  in  each  year,  and,  in  default 
of  this,  to  pay  the  lessors  for  the  minimum  amount  specified,  and  take 
credit  therefor  and  apply  such  sums  upon  ore  mined  and  shipped  thereafter 
in  excess  of  such  minimum.  The  lessees  were  to  pay  the  taxes  and  to  keep 
the  property  free  from  encumbrances  and  liens.  Right  was  reserved  to 
terminate  the  contract  upon  the  failure  of  the  lessees  to  comply  with  the 
terms  thereof. 

The  form  of  the  leases  is  shown  in  Exhibits  15  and  16,  which  were  not 
in  the  printed  record,  owing  to  their  length,  but  copies  of  which,  pursuant 
to  stipulation,  have  been  sent  to  this  court.  An  examination  of  Exhibit 
16  shows  that  the  lessees  had  the  right  to  terminate  and  surrender  the 
lease  by  giving  the  lessors,  or  those  having  their  estate  in  the  premises, 
sixty  days'  written  notice,  and  executing  sufficient  conveyances  releasing 
all  interest  and  right  of  the  lessees  in  the  premises  with  any  improvements 
thereon,  and  surrendering  the  same  in  good  order  and  condition,  etc.,  and 
that  thereupon  all  liability  of  the  lessees  to  taxes  subsequently  assessed  on 
the  demised  premises  or  for  rent  thereof  thereafter  to  accrue,  or  royalty 
on  ores  therefrom  except  on  account  of  ores  removed,  should  cease  and 
determine;  the  lessees  to  be  liable  for  all  ores  removed  from  the  premises 
not  theretofore  paid  for,  and  to  pay  for  the  premises  rent  or  royalty  for 
the  year  in  which  termination  should  be  made,  or  the  portion  thereof  which 
should  have  expired,  at  the  rate  of  $12,500.00  per  annum. 

Since  their  organization  the  corporations  have  disposed  of  certain 
lands  and  have  also  disposed  of  the  stumpage  on  some  timber  lands.  Cer- 
tain parcels  were  rented  and  leased,  and  a  village  was  allowed  to  use 
part  of  the  land  for  schoolhouse  purposes,  as  well  as  another  part  for  a 
public  park. 

To  insure  the  proper  carrying  on  of  the  mining  operations,  the  com- 
panies employed  another  corporation,  engaged  in  engineering  and  inspec- 
tion of  ore  properties,  to  provide  supervision  and  inspection  of  the  work 
upon  the  respondents'  properties,  for  which  the  inspecting  company  was 
paid  from  month  to  month,  as  statements  were  rendered. 

The  companies  were  assessed  upon  their  gross  income,  being  the  entire 
receipts  of  the  companies  from  .royalties  on  the  leases  collected  in  the 
years  1909,  1910,  and  1911,  and  some  sums  received  from  the  sales  of 
lots,  lands  and  stumpage,  from  which  expenses  and  taxes  were  deducted, 
but  no  deduction  was  made  upon  account  of  the  depletion  of  the  ore  in 
the  properties,  or  on  account  of  such  sales. 

The  brief  for  the  respondents  states  that  these  cases  present  for  con- 
sideration four  questions,  which  are: 

"1.     Are  the  respondents  corporations  organized  for  profit? 

"2.  Were  the  respondents  carrying  on  or  doing  business  during  the 
years  1909,  1910,  1911? 

"3.     Were  moneys  received  by  the  respondents  during  those  years  in 


CAPITAL    STOCK    TAX  357 

payment  for  iron  ore,  under  the  contracts  covering  their  mineral  lands, 
gross  income,  or  did  they  represent,  in  whole  or  in  part,  the  conversion 
of  the  investment  of  the  corporations  from  ore  into  money? 

"4.  If  such  moneys  were  gross  income,  are  the  respondents  entitled 
to  make  any  deduction  therefrom  on  account  of  the  depletion  of  their  capi- 
tal investment?" 

1.     The  Companies  Webe  Obganized  fob  Pbofit. 


2.    They  Webe  Cabbying  on  ob  Doing  Business  within  the  Meaning 
of  the  Act  of  1909. 

As  to  the  second  question:  Were  the  respondents  carrying  on  busi- 
ness, within  the  meaning  of  the  Corporation  Tax  Act?  This  question  was 
dealt  with  by  this  court  in  the  first  of  the  Corporation  Tax  Cases,  Flint 
v.  Stone  Tracy  Company,  220  U.  S.  107.  As  the  tax  was  there  held  to 
be  assessed  upon  the  privilege  of  doing  business  in  a  corporate  capacity, 
it  became  necessary  to  inquire  what  it  was  to  do  business,  and  this  court 
adopted  with  approval  the  definition,  judicially  approved  in  other  cases, 
which  included  within  the  comprehensive  term  "business"  that  which  oc- 
cupies the  time,  attention  and  labor  of  men  for  the  purpose  of  a  livelihood 
or  profit." 

In  that  case  a  number  of  realty  and  mining  companies  were  dealt 
with,  and  the  Park  Realty  Company,  organized  to  deal  in  real  estate,  and 
engaged  at  the  time  in  the  management  and  leasing  of  a  certain  hotel, 
was  held  to  be  engaged  in  business.  It  was  also  held  that  the  Clark  Iron 
Company,  organized  under  the  laws  of  Minnesota,  and  owning  and  leasing 
ore  lands  for  the  purpose  of  carrying  on  mining  operations,  and  receiving 
a  royalty  depending  upon  the  quantity  of  ore  mined,  was  engaged  in 
business. 

At  the  same  time,  and  decided  with  the  main  corporation  tax  case, 
this  court  held,  in  the  case  of  Zonne  v.  Minneapolis  Syndicate,  220  U.  S. 
187,  that  a  corporation  which  owned  a  piece  of  real  estate  which  had  been 
leased  for  130  years,  at  an  annual  rental  of  $61,000,  and  which  had 
amended  its  articles  of  incorporation  so  as  to  limit  its  purposes  to  holding 
the  title  to  the  property  mentioned,  and,  for  the  convenience  of  its  stock- 
holders, to  receiving  and  distributing  from  time  to  time  the  rentals  that 
accrued  under  the  lease  and  the  proceeds  of  any  disposition  of  the  land, 
was  not  engaged  in  doing  business  within  the  meaning  of  the  act,  by  reason 
of  the  fact  that  the  corporation  had  practically  gone  out  of  business  and 
had  disqualified  itself  from  any  activity  in  respect  thereto. 

The  act  next  came  before  this  court  in  the  case  of  McCoach,  Col- 
lector, v.  Minehill  Railway  Company,  228  U.  S.  295,  in  which  it  was 
held,  distinguishing  the  case  of  the  Park  Realty  Company,  supra,  and 
applying  the  case  of  Zonne  v.  Minneapolis  Syndicate  supra,  to  the  facts 
before  the  court,  that  a  corporation  which  had  leased  all  its  property 
to  another,  and  was  doing  only  what  was  necessary  to  receive  and  distribute 


358  INCOME    AND    FEDERAL    TAX    REPORTS 

the  income  therefrom  among  stockholders,  was  not  doing  business  within 
the  meaning  of  the  act. 

In  United  States  v.  Emery,  237  U.  S.  28,  this  court  held  that  a 
corporation  which  merely  kept  up  its  organization,  distributing  rent 
received  from  a  single  lessee,  was  not  doing  business  within  the  meaning 
of  the  act. 

It  is  evident,  from  what  this  court  has  said  in  dealing  with  the 
former  cases,  that  the  decision  in  each  instance  must  depend  upon  the 
particular  facts  before  the  court.  The  fair  test  to  be  derived  from  a  con- 
sideration of  all  of  them  is  between  a  corporation  which  has  reduced  its 
activities  to  the  owning  and  holding  of  property  and  the  distribution  of 
its  avails  and  doing  only  the  acts  necessary  to  continue  that  status,  and 
one  which  is  still  active  and  is  maintaining  its  organization  for  the  pur- 
pose of  continued  efforts  in  the  pursuit  of  profit  and  gain  and  such  activi- 
ties as  are  essential  to  those  purposes. 

From  the  facts  clearly  established  in  these  cases,  we  think  these  cor- 
porations were  doing  business,  within  the  meaning  of  the  act.  They  were 
organized  for  the  purposes  stated,  and  their  activities  included  something 
more  than  the  mere  holding  of  property  and  the  distribution  of  the  receipts 
thereof.  As  was  found  by  the  District  Court,  the  evidence  shows  that  these 
three  companies  sold,  during  each  of  the  years  named,  quantities  of  real 
estate,  and  the  same  were  not  small.  They  sold  stumpage  from  some  of 
the  properties  which  had  been  burned  over,  leased  certain  properties  in 
the  village  of  Hibbing,  and  granted  leases  to  squatters.  One  of  the  com- 
panies made  explorations  and  incurred  expenses  in  the  matter  of  test  pits. 
They  employed  another  company  to  see  that  the  mining  operations  were 
properly  carried  on,  and  that  the  lessees  lived  up  to  the  engagements  of 
their  contracts.  "All  these  things  indicate,"  said  the  learned  district 
judge,  "the  doing  of  and  engaging  in  business.  It  [the  corporation]  was 
doing  the  business  of  handling  a  large  property,  selling  lots,  and  seeing 
that  the  lessees  lived  up  to  their  contracts.  If  that  is  not  engaging  in 
business,  I  do  not  know  what  is."  We  agree  that  it  certainly  was  doing 
business,  and,  as  the  Corporation  Tax  Act  requires  no  particular  amount 
of  business  in  order  to  bring  a  company  within  its  terms,  we  think  these 
activities  brought  the  corporations  in  question  within  that  line  of  decisions 
in  this  court  which  have  held  such  corporations  were  doing  business  in 
a  corporate  capacity  within  the  meaning  of  the  law. 

3.     The  Royalties  Received  from  Lessees  were  Income. 


4.    No  Allowance  Could  be  Claimed  Under  the  Corporation  Tax  Act 
or  1909  for  Depletion  of  Natural  Resources. 


Judgments  reversed. 


CAPITAL    STOCK    TAX  359 

In  this  decision  the  court  states:  "It  is  evident  from 
what  this  court  has  said  in  dealing  with  the  former 
cases,  that  the  decision  in  each  instance  must  depend 
upon  the  particular  facts  before  the  court.  The  fair 
test  to  be  derived  from  all  of  them  is  between  a  cor- 
poration which  has  reduced  its  activities  to  the  owning 
and  holding  of  property  and  the  distribution  of  its 
avails  and  doing  only  the  acts  necessary  to  contiaue 
that  status,  and  one  which  is  still  active  and  is  main- 
taining its  organization  for  the  purpose  of  continued 
efforts  in  the  pursuit  of  profit  and  gain  and  such  activi- 
ties as  are  essential  to  those  purposes.  From  the  facts 
clearly  established  in  these  cases,  we  think  these  cor- 
porations were  doing  business  within  the  meaning  of 
the  Act." 

This  decision,  published  as  T.  D.  2436,  laid  down  the 
general  rule  but  did  not  cover  any  of  the  cases  relat- 
ing specifically  to  holding  companies.  In  March,  1917, 
the  United  States  District  Court,  Southern  District  of 
New  York,  upheld  the  decision  in  United  States  vs. 
Nippissing  Mines  Company  in  deciding  the  case  of  The 
Butterick  Company  vs.  United  States  (206  Fed.  431). 
The  court  said:  "The  Government  contends  that  the 
direction  of  the  management  of  the  subsidiary  com- 
panies by  the  holding  company  was  a  doing  of  business 
which  subjected  the  holding  company  to  an  excise  tax. 
This  direction  was  accomplished  only  by  the  control  of 
the  subsidiary  companies  through  stock  ownership.  Of 
course,  proxies  had  to  be  issued  to  vote  at  the  meetings 
of  the  operating  companies,  and  the  directors  of  the 
latter  were  chosen  by  the  owners  of  the  stock.  No 
holding  company  can  exist  without  a  corporate  activity 
involved  in  the  exercise  of  such  control  through  its 
stock  ownership  in  the  operating  company,  but  such 
corporate  activity  is  not,  under  the  authority  of  the 
United  States  vs.  Nippissing  Mines  Company  (206  Fed. 
431),  the  exercise  of  a  franchise  which  is  subject  to  an 


360  INCOME    AND    FEDERAL    TAX   REPORTS 

excise  tax.  The  endorsement  by  the  Butterick  Com- 
pany of  the  notes  of  its  subsidiary  company  was  the 
only  fact  which  is  to  be  added  to  the  facts  before  the 
court  in  the  case  of  United  States  vs.  Nippissing  Mines 
Company,  supra,  which  was  decided  by  the  Circuit 
Court  of  this  circuit,  but  this  is  not  sufficient  to  differ- 
entiate that  case  from  the  action  by  the  Butterick  Com- 
pany here  under  consideration." 

The  decision  in  the  above  case  is  not  a  Supreme 
Court  decision,  and  therefore  does  not  affect  the  De- 
partment's ruling  that  holding  companies  are  tax- 
able. 

In  the  cases  of  real  estate  companies  and  other  com- 
panies that  have  leased  their  entire  property  for  a 
period  of  years,  the  rule  laid  down  in  Baumbach  vs. 
Sargent  Realty  Company,  as  stated  above,  forms  the 
best  basis  for  deciding  whether  or  not  such  a  company 
is  taxable. 

With  reference  to  a  real  estate  corporation  that 
was  holding  real  estate  for  enhancement  in  value,  mak- 
ing no  sales  whatever  during  the  fiscal  year  July  1, 
1916,  to  June  30,  1917,  the  Treasury  Department 
ruled : 

"The  fact  that  this  corporation  is  holding  its  prop- 
erty until  it  can  obtain  a  fair  price  for  it  would  indi- 
cate that  the  company  is  engaged  in  business  for  profit. 
As  the  corporation  is  performing  some  of  the  functions 
for  which  it  is  incorporated,  it  will,  of  course,  be  re- 
quired to  file  a  return  of  capital  stock  on  Form  707  and 
pay  the  special  excise  tax  for  the  period  July  1,  1917, 
to  June  30,  1918,  and  file  that  report  during  July, 
1917. 

When  is  a  foreign  corporation  engaged  in  business  in  the 
United  States? — The  question  of  just  what  activities  are 
necessary  in  order  that  a  foreign  corporation  may  be 
held  as  doing  business  in  the  United  States  has  been 


CAPITAL    STOCK    TAX  361 

passed  on  in  decisions  under  the  corporation  tax  law 
of  August  5,  1909.  These  decisions  are  reviewed  in  the 
case  of  Laurenlide  Company,  Limited,  vs.  Durey,  Col- 
lector of  Internal  Revenue  (231  Fed.  223). 

The  court  states  "doing  business  within  the  state"  or 
"doing  or  transacting  business  in  the  United  States" 
do  not  include  the  doing  of  a  single  act  or  the  making 
of  single  contract,  but  do  include  a  "continued  series  of 
acts  by  an  agent  or  agents  continuously  within  the  state 
or  the  United  States,  as  the  case  may  be." 

From  this  decision  it  will  be  seen  that  any  corpora- 
tion maintaining  an  agency  or  having  a  resident  agent 
in  the  United  States  will  be  held  as  doing  business  in 
the  United  States.  The  tax,  though,  is  based  upon 
capital  invested  in  the  United  States,  and  there  are  any 
number  of  firms  doing  a  large  volume  of  business  with- 
out having  any  capital  in  the  United  States. 

Take  the  case  of  a  foreign  steamship  company  plying 
between  England  and  the  United  States.  The  steam- 
ships, if  registered  in  a  foreign  port,  cannot  properly 
be  considered  as  "capital  actually  invested  in  the  trans- 
action of  business  in  the  United  States."  The  value  of 
the  steamships,  therefore,  should  not  be  included  as 
capital  invested  in  the  transaction  of  business  in  the 
United  States  on  Form  708,  although  a  return  of  cap- 
ital stock  should  be  filed  irrespective  of  the  amount  of 
capital  employed  either  abroad  or  in  this  country,  in- 
asmuch as  this  company  was  engaged  in  business  in  the 
United  States.  A  leasehold  interest  in  a  dock  in  this 
country,  however,  may  properly  be  considered  as  an 
asset  of  a  foreign  corporation  and  part  of  its  capital 
invested  in  the  United  States. 

The  basis  of  the  tax,  and  methods  of  valuation. — The 
Capital  Stock  Tax  is  an  excise  tax,  payable  in  advance, 
for  the  privilege  of  doing  business  for  a  fiscal  year. 
The  amount  of  the  tax  is  computed  upon  the  average 


362  INCOME    AND    FEDERAL    TAX    REPORTS 

fair  value  of  the  capital  stock  of  the  company  for  the 
preceding  fiscal  year  at  the  rate  of  fifty  cents  ($.50) 
for  each  full  $1,000.00  of  such  fair  value. 

The  fair  value  of  the  capital  stock  of  a  corporation 
can  be  only  an  estimate.  The  Treasury  Department, 
therefore,  furnishes  three  methods  of  estimating  the 
fair  value  of  the  capital  stock  of  United  States  cor- 
porations. These  methods  are  to  be  used  in  different 
cases  to  which  they  may  be  applicable  or  appropriate: 
Case  I,  where  the  stock  is  listed  on  an  exchange;  Case 
II,  where  the  stock  is  not  listed  on  an  exchange  but 
where  sales  of  the  stock  have  been  made  during  the 
preceding  fiscal  year;  Case  III,  where  the  stock  is  not 
listed  on  any  exchange  and  where  no  sales  have  been 
made  or  where  sales  have  been  made  and  the  price  is 
unknown. 

Case  I.  Where  the  stock  is  listed  on  an  exchange. — If 
the  stock  is  listed  on  any  exchange  its  fair  value  will 
be  determined  by  adding  the  quoted  highest  bid  price 
for  the  stock  on  the  last  day  of  each  month  during  the 
preceding  fiscal  year  (or  if  no  bid  price  was  quoted  on 
the  last  day  of  each  month  then  the  latest  day  in  the 
month  on  which  a  bid  was  quoted)  and  dividing  by  12, 
the  result  being  the  average  bid  price  per  share  for  that 
year.  A  corporation,  if  it  prefers,  may  average  the  fair 
value  throughout  the  entire  fiscal  year  by  showing  on 
a  statement  attached  to  the  back  of  the  return  the  high- 
est price  bid  for  the  stock  on  each  day  throughout  the 
year. 

Where  the  stock  is  subject  to  great  fluctuations  and 
the  highest  bid  prices  on  the  last  day  of  each  month 
do  not  indicate  the  fair  value  of  the  stock,  the  corpora- 
tion should  calculate  the  average  bid  price  as  in- 
structed above  and  attach  to  the  return  a  statement 
showing  why  the  figures  under  the  case  do  not  indi- 
cate a  fair  value  of  the  stock.     This  statement  will  be 


CAPITAL    STOCK   TAX  363 

taken  into  consideration  when  the  assessment  of  the 
tax  is  made. 

Case  II.  Where  the  stock  is  not  listed  on  an  exchange 
but  where  sales  have  been  made. — If  the  stock  is  not 
listed  on  any  exchange,  but  sales  thereof  have  actually 
been  made,  and  the  price  paid  for  the  stock  is  known 
to  the  officer  making  the  return,  or  can  be  dis- 
covered by  him,  the  average  price  at  which  sales 
were  made  during  the  preceding  fiscal  year  shall  be 
the  determining  factor  in  ascertaining  the  fair  value 
per  share. 

The  "average  price  at  which  sales  were  made"  should 
be  used,  and  not  the  average  selling  price  per  share. 
Thus  if  10  shares  were  sold  at  $100  and  1,000  shares 
were  sold  at  $70,  the  "average  price"  at  which  sales 

100  +  70 
were  made  would  be  $85  I  =  85   I ,  which  is 


(100  +  70  \ 


the  correct  figure  to  use.     The  "average  selling  price" 

/  10  X  100  +  1,000  X  70 

in  such  a  case  would  be  $70.29  I  

\  1,010 

=  70.29  1 ,  but  this  price  will  not  be  accepted  as  an 


average  fair  value.  Corporations  protesting  against 
this  method  of  computing  the  value  of  stock  may  file  a 
statement  with  the  return  setting  forth  the  facts  in  de- 
tail and  requesting  the  local  collector  to  bring  the  mat- 
ter to  the  attention  of  the  Commissioner  of  Internal 
Eevenue. 

Where  the  number  of  sales  is  small  and  the  circum- 
stances attending  the  sales  are  such  that  they  do  not 
indicate  the  fair  value,  the  same  procedure  should  be 
followed  as  suggested  in  Case  I.  The  average  price  at 
which  sales  are  made  should  be  calculated  and  a  state- 
ment attached  to  the  report  showing  why  it  does  not 
represent  the  fair  value. 


INCOME   AND    FEDERAL    TAX   REPORTS 

Case  III.  If  the  stock  is  not  listed  on  an  exchange  or  if 
no  sales  have  been  made. — If  Case  I  and  Case  II  cannot 
be  applied,  i.  e.,  if  the  stock  is  not  listed  on  any  ex- 
change, and  no  actual  sales  have  been  made  during  the 
preceding  fiscal  year,  or  if  the  price  at  which  sales 
have  been  made  is  not  known  to  the  officer  making  the 
return,  the  fair  average  value  of  the  capital  stock  shall 
be  estimated,  and  the  surplus  and  undivided  profits  for 
the  preceding  fiscal  year  will  be  taken  into  considera- 
tion as  required  by  the  statute,  as  well  as  the  nature 
of  the  business,  its  earning  capacity  and  average  divi- 
dends paid  or  profits  earned  during  the  preceding  five 
years.     (Reg.  38.) 

The  book  value  of  a  stock  includes  the  total  par 
value  of  the  stock,  the  surplus,  and  the  undivided 
profits.  Thus,  if  a  corporation  has  10,000  shares,  par 
$100  per  share,  a  surplus  of  $500,000,  and  undivided 
profit  of  $50,000,  the  book  value  of  its  stock  would  be 
$1,550,000,  unless  for  any  reason  the  book  value  is  fic- 
titious because  in  some  way  the  assets  have  been  over- 
estimated in  the  books  of  the  corporation. 

The  real  value  of  a  stock  is  determined  by  its  earn- 
ing capacity.  A  reasonable  return  per  share  will  make 
a  stock  worth  par.  As  the  return  increases  the  real 
value  of  the  stock  increases  proportionately.  If  a  re- 
turn of  10%  will  make  a  stock  worth  par,  a  return  of 
20%  will  make  its  real  worth  twice  par.  If  the  par  is 
$100,  the  real  value  per  share  is  then  $200.  If  the  re- 
turn is  5%,  then  the  real  value  of  the  stock  is  $50.  Just 
what  rate  of  return  is  required  to  make  a  stock  worth 
par  depends  upon  the  nature  and  hazards  of  the  busi- 
ness of  the  corporation. 

The  Treasury  Department  has  issued  a  statement  of 
the  rate  of  return  on  different  classes  of  corporations 
which  in  its  opinion  is  required  to  make  their  stock 
worth  par. 


CAPITAL    STOCK    TAX  365 

Class  of  Corporation  Per  Cent. 

Banking: 

States  west  of  Mississippi  River 8 

States  east  of  Mississippi  River 6 

Mining 10 

Mercantile 10 

Industrial 10 

Oil-producing  companies 15 

Oil-refining  companies 10 

Public  utilities 8 

The  stock  of  a  manufacturing  corporation  earning 
20%  would  be  worth  $200  a  share.  Multiplied  by  the 
number  of  shares  outstanding,  this  would  give  the  total 
fair  value  of  the  capital  stock. 

The  earning  capacity  should  be  taken  from  the  aver- 
age profits  per  share  for  the  last  five  years.  The  net 
income  each  year  need  not  be  taken  from  the  income 
tax  returns  of  that  year.  There  are  cases  where  the 
corporation  has  income  which  is  not  taxable  under  the 
income  tax  law  or  where  the  corporation  has  actually 
incurred  expenses  which  are  not  deductible  in  the  cal- 
culation of  the  income  tax.  For  instance,  that  income 
which  is  derived  from  investments  in  bonds  or  securi- 
ties of  a  State,  municipality,  or  of  the  United  States, 
that  is  not  taxable  under  the  income  tax  laws,  should 
be  included  in  the  total  net  income  entered  on  the  re- 
turn under  Case  III,  inasmuch  as  this  income  was  a 
great  influence  at  times,  so  far  as  the  valuation  of  a 
particular  stock  is  concerned. 

In  the  same  way,  interest  actually  paid  during  the 
year  is  not  at  all  times  allowed  as  an  expense  of  opera- 
tion of  a  corporation,  due  to  the  limitations  as  to  the 
maximum  that  may  be  charged  as  an  expense.  (See 
Chapter  IX.)  Nevertheless,  the  total  interest  paid  dur- 
ing the  year  should  be  included  as  an  expense  when  de- 
termining net  income  for  capital  stock  valuation.  In 
such  cases  the  corporation  should  use  the  figures  actu- 


366 


INCOME   AND    FEDERAL    TAX   REPORTS 


ally  shown  on  its  books  and  which  reflect  its  true  earn- 
ing capacity. 

The  net  income  each  year  should  be  divided  by  the 
number  of  shares  outstanding1  each  year,  the  result 
being  the  earnings  per  share.  If  the  par  value  of  the 
shares  is  $100,  the  dollars  earned  per  share  is  equiva- 
lent to  the  per  cent  earned  per  share.  If  the  shares 
are  more  or  less  than  $100  par,  the  per  cent  earned 
must  then  be  calculated  by  dividing  the  earnings  per 
share  by  the  par  value  of  the  share. 

To  determine  the  average  per  cent  earned,  add  the 
per  cents  earned  per  share  in  each  of  the  five  years  and 
divide  by  5.  The  rate  thus  determined  should  be 
capitalized  at  the  fair  rate  of  return  so  as  to  give  the 
fair  value  per  share,  as  indicated  below. 


Average 
Per  Cent. 

Fair  Value  per  Share  (par  $100.00) 

Earned 

At  6% 

At  8% 

At  10% 

At  15% 

At  20% 

6 

100 

75 

60 

40 

30 

7 

116 

87 

70 

46 

35 

8 

133 

100 

80 

53 

40 

9 

150 

113 

90 

60 

45 

10 

167 

125 

100 

67 

50 

11 

184 

137 

110 

74 

55 

12 

200 

150 

120 

81 

60 

13 

216 

163 

130 

87 

65 

14 

233 

175 

140 

94 

70 

15 

250 

188 

150 

100 

75 

16 

267 

200 

160 

107 

80 

17 

284 

213 

170 

113 

85 

18 

300 

225 

180 

120 

90 

19 

316 

237 

190 

126 

95 

20 

333 

250 

200 

133 

100 

21 

350 

263 

210 

139 

105 

22 

367 

275 

220 

146 

110 

23 

384 

288 

230 

153 

115 

24 

400 

300 

240 

160 

120 

i  Capital  stock  which  has  been  issued  by  a  corporation  is  regarded  as 
being  outstanding,  even  though  it  is  afterwards  acquired  by  the  company 
for  value,  and  carried  on  the  books  as  treasury  stock. 


CAPITAL    STOCK   TAX  367 

Fair  value  of  total  capital  stock. — The  fair  value  of  the 
total  capital  stock  is  found  by  multiplying  the  fair  value 
per  share  by  the  number  of  shares  outstanding  at  the 
date  of  making  the  return  unless  the  number  of  shares 
outstanding  has  changed  during  the  fiscal  year. 

Increases  or  decreases  in  capital  stock  during  fiscal  year. 
— Where  the  capital  stock  has  been  increased  or  de- 
creased the  case  will  be  governed  by  the  ruling  laid 
down  in  T.  D.  2503,  which  reads  as  follows: 

"If  a  corporation  has  increased  or  decreased  its  cap- 
ital stock  during  the  fiscal  year,  a  statement  should  be 
attached  to  the  back  of  the  return  setting  forth  the 
number  of  shares  of  stock  outstanding  each  month,  with 
the  average  fair  value  of  the  stock  for  that  month, 
computed  under  one  of  the  three  cases." 

The  method  of  applying  these  instructions  under  va- 
rious circumstances  is  as  follows: 

Proposition  I. — Books  of  the  corporation  on  Dec.  31, 
1916  show: 

Capital  Stock,  1,000  shares,  par  $100.    Total.  $100,000 
Surplus    100,000 


Total  Book  Value $200,000 

On  January  1,  1917,  a  stock  dividend  of  100%  is 
declared. 

The  average  earnings  are  $20  per  share,  or  $20,000 
per  year. 

Methods  of  determining  fair  value  under  the  three 
cases  mentioned  above  are  as  follows: 


INCOME    AND    FEDERAL    TAX    REPORTS 

Case  I 


No  of 

Highest 

Year 

Month 

Shares 
Outstanding 

Average 
Bid  Price 
for  Month 

Fair 
Value 

1916 

July 

1,000 

$210 

$210,000 

August 

1,000 

205 

205,000 

September 

1,000 

200 

200,000 

October 

1,000 

195 

195,000 

November 

1,000 

190 

190,000 

December 

1,000 

200 

200,000 

1917 

January 

2,000 

105 

210,000 

February 

2,000 

100 

200,000 

March 

2,000 

90 

180,000 

April 

2,000 

110 

220,000 

May 

2,000 

95 

190,000 

June 

2,000 

100 

200,000 

$2,400,000 

$2,400,000-^12  =  $200,000,  average  fair  value. 

Case  II 
The  same  procedure  is  followed  as  in  Case  I,  except 
that  "Highest  Sales  Price  During  Month"  is  taken  in- 
stead of  "Highest  Average  Bid  Price  for  Month." 

Case  III 

The  average  earnings  of  $20  per  share  would  give  an 
estimated  fair  value  per  share  (if  the  corporation  is  an 
industrial  or  mining  company)  of  $200  per  share.  The 
question  that  arises  is,  "By  what  number  of  shares 
should  this  fair  value  per  share  be  multiplied  in  order 
to  arrive  at  the  average  fair  value  of  the  capital  stock?" 
The  face  of  the  return  (Form  707)  calls  for  the  number 
of  shares  outstanding  at  the  time  of  filing  the  return,  in 
this  case  2,000  shares;  the  instructions  on  the  reverse 
of  the  form  are  that  the  average  number  of  shares  out- 
standing should  be  used,  in  this  case  1,500  shares. 

Neither  of  the  methods  would  give  a  true  value.  The 
increased  number  of  shares  merely  represent  a  trans- 


CAPITAL    STOCK    TAX 


369 


fer  from  the  surplus  to  the  par  value  of  the  capital 
stock  outstanding.  The  amount  of  capital  invested  is 
the  same  and  there  should  be  no  increase  in  the  total 
fair  value  of  the  stock. 

The  method  suggested  by  the  Department  when  this 
specific  case  was  put  before  them  was  to  calculate  the 
average  earnings  of  the  shares  outstanding  June  30, 
1917,  which  would  give  an  average  earning  per  share  of 
$10,  and  a  fair  value  per  share  of  $100,  and  then  to 
multiply  by  the  number  of  shares  outstanding  on  June 
30,  1917,  or  2,000  shares.  This  would  give  a  total  fair 
value  of  $200,000.  This  method  suggested  by  the  Gov- 
ernment has  the  merit  of  basing  the  entire  problem  on 
the  number  of  shares  that  are  actually  outstanding  at 
the  time  of  making  the  return. 

Proposition  II. — On  December  31,  1916,  a  corpora- 
tion has  outstanding  1,000  shares,  par  $100,  total  $100,- 
000.  On  January  1,  1917,  another  1,000  shares  are  is- 
sued for  cash  at  par.  The  average  rate  of  earnings  is 
$10  per  share,  or  $10,000  per  year. 

Case  I 


; 

No.  of 

Highest 

Fair 
Value 

Year 

Month 

Shares 

Quoted 

Outstanding 

Bid  Price 

1916 

July 

1,000 

$99 

$99,000 

August 

1,000 

101 

101,000 

September 

1,000 

103 

103,000 

October 

1,000 

102 

102,000 

November 

1,000 

98 

98,000 

December 

1,000 

101 

101,000 

1917 

January 

2,000 

97 

194,000 

February 

2,000 

100 

200,000 

March 

2,000 

99 

198,000 

April 

2,000 

101 

202,000 

May 

2,000 

100 

200,000 

June 

2,000 

99 

198,000 

$1,796,000 

$1,796,000  -=- 12  =  $149,666,  average  fair  value. 


370 


INCOME    AND    FEDERAL    TAX    REPORTS 


Case  II 


No.  of 

Highest 

Fair 
Value 

Year 

Month 

Shares 

Sale  Price 

Outstanding 

Each  Month 

1916 

July 

1,000 

$101 

$101,000 

August 

1,000 

101 

101,000 

September 

1,000 

101 

101,000 

October 

1,000 

99 

99,000 

November 

1,000 

100 

100,000 

December 

1,000 

100 

100,000 

1917 

January- 

2,000 

102 

204,000 

February 

2,000 

102 

204,000 

March 

2,000 

102 

204,000 

April 

2,000 

98 

196,000 

May 

2,000 

98 

196,000 

June 

2,000 

98 

196,000 

$1,802,000 

$1,802,000  -f- 12  =  $150,166,  average  fair  value. 
If   there   was  no   sale   during   the   month,   the   last 
month's  price  should  be  used. 

Case  III 

The  average  rate  of  earnings  of  $10  would  give  a 
fair  value  per  share  of  $100.  This  should  be  multiplied 
by  the  average  number  of  shares  outstanding  during  the 
year,  or  1,500  shares,  giving  an  average  fair  value  of 
$150,000,  due  to  the  fact  that  the  additional  number  of 
shares  issued  by  the  corporation  were  sold  for  cash  and 
the  capital  stock  of  the  corporation  was  increased  to 
that  extent. 

Proposition  HI. — Corporation  books  on  December  31, 
1916,  show: 

Capital  Stock  (1,000  shares  at  $100) $100,000 

Surplus    100,000 


$200,000 


CAPITAL    STOCK    TAX 


371 


On  January  1,  1917,  1,000  additional  shares  were  is- 
sued and  paid  for  at  par.  The  earnings  average  $20 
per  share,  or  $20,000  per  year. 

Case  I 


No.  of 

Highest 

Fair 

Value 

Year 

Month 

Shares 

Quoted 

Outstanding 

Bid  Price 

1916 

July 

1,000 

$200 

$200,000 

August 

1,000 

205 

205,000 

September 

1,000 

210 

210,000 

October 

1,000 

200 

200,000 

November 

1,000 

195 

195,000 

December 

1,000 

190 

190,000 

1917 

January 

2,000 

150 

300,000 

February 

2,000 

155 

310,000 

March 

2,000 

145 

290,000 

April 

2,000 

150 

300,000 

May 

2,000 

160 

320,000 

June 

2,000 

140 

280,000 

$3,000,000 

$3,000,000 -f- 12  =  $250,000,  average  fair  value. 

Case  II 


No.  of 

Highest 

Fair 

Value 

Year 

Month 

Shares 

Quoted 

Outstanding 

Bid  Price 

1916 

July 

1,000 

$200 

$200,000 

August 

1,000 

200 

200,000 

September 

1,000 

195 

195,000 

October 

1,000 

195 

195,000 

November 

1,000 

205 

205,000 

December 

1,000 

205 

205,000 

1917 

January 

2,000 

155 

310,000 

February 

2,000 

155 

310,000 

March 

2,000 

155 

310,000 

April 

2,000 

145 

290,000 

May 

2,000 

145 

290,000 

June 

2,000 

145 

290,000 

$3,000,000 

$3,000,000  -=- 12  =  $250,000,  average  fair  value. 


372  INCOME   AND   FEDERAL    TAX   REPORTS 

If  no  sale  has  been  made  during  the  month,  the  fig- 
ures of  the  previous  month  should  be  used. 

Case  III 

The  average  earnings  are  $20  a  share,  which  would 
give  a  fair  value  of  $200  per  share.  If  this  were  mul- 
tiplied by  the  average  number  of  shares  outstanding, 
1,500  shares,  it  would  give  a  fair  value  of  $300,000. 
This  is  not  the  average  fair  value  of  the  total  capital 
stock,  which  was  figured  under  Cases  I  and  II  to  be 
$250,000.  The  doubling  of  the  number  of  shares  did 
not  mean  the  doubling  of  the  amount  of  capital.  The 
Gapital  December  31,  1916,  was  $200,000  (capital  stock, 
$100,000;  surplus,  $100,000).  On  January  1,  1917,  an 
additional  $100,000  was  added,  bringing  the  capital  up 
to  $300,000.  This  would  make  the  average  capital 
$250,000.  In  a  case  similar  to  this  a  statement  should 
be  attached  to  the  back  of  the  return  setting  forth  the 
number  of  shares  of  stock  outstanding  each  month,  with 
the  average  fair  value  of  the  stock  for  that  month,  as 
worked  out  in  Cases  I  and  II. 

Bate  of  earnings  if  calculated  on  the  basis  of  capital. — 
If  the  earnings  are  calculated  on  the  basis  of  the  cap- 
ital (i.  e.,  par  value  of  issued  stock  plus  the  surplus  or 
undivided  profits),  instead  of  the  number  of  shares,  we 
can  arrive  at  a  fair  value  of  the  invested  capital.  If 
after  determining  this  fair  value  of  the  invested  capital 
the  amount  of  capital  is  increased  or  decreased,  the 
value  of  the  invested  capital  is  increased  or  decreased 
proportionately.  Increases  or  decreases  in  capital  stock 
are  ignored  except  as  the  result  of  an  increase  or  de- 
crease in  the  amount  of  invested  capital.  In  all  cases 
this  method  would  give  the  figure  required  by  the  law, 
namely,  "the  average  fair  value  of  the  capital  stock  for 
the  preceding  fiscal  year." 

Turning  back  to  the  cases  given  in  the  foregoing  para- 
graphs, the  method  would  work  out  as  follows: 


CAPITAL    STOCK    TAX  373 

In  Proposition  I  the  capital  of  $200,000  has  an  earn- 
ing power  of  $20,000  per  year.  The  corporation  being 
an  industrial  company,  the  fair  value  of  the  capital  is 
$200,000.! 

The  issuing  of  $100,000  par  value  of  capital  stock  to 
distribute  the  100%  stock  dividend  neither  increased  nor 
decreased  the  amount  of  capital  invested.  The  fair 
value  of  the  capital  remains  at  $200,000. 

In  Proposition  II  the  capital  was  $100,000  and  the 
earnings  were  $10,000  per  year.  This  gives  the  fair 
value  of  the  capital  as  $100,000.  On  January  1,  1917, 
1,000  shares  are  issued  for  cash  at  par.  This  transac- 
tion adds  $100,000  to  the  capital,  an  increase  of  100%. 
The  fair  value  of  the  capital  is  increased  proportion- 
ately, becoming  $200,000.  The  tax,  however,  is  based 
on  the  average  fair  value  during  the  year.  The  fair 
value  for  the  six  months  from  July  1,  1916,  to  Dec.  31, 
1916,  was  $100,000;  from  Jan.  1,  1917,  to  June  30,  1917, 
it  was  $200,000.  The  average  fair  value  is  therefore 
$150,000. 

In  Proposition  III  the  capital  and  the  earning  power 
are  the  same  as  in  Proposition  I,  the  fair  value  of  the 
capital  being  $200,000.  On  January  1,  1917,  1,000  shares 
are  sold  at  par.  This  transaction  adds  $100,000  to  the 
capital,  an  increase  of  50%.  The  fair  value  of  the  cap- 
ital is  increased  proportionately,  becoming  $300,000. 
The  average  fair  value  of  the  capital  is  therefore  $250,- 
000  ($200,000  for  the  first  six  months  and  $300,000  for 
the  second  six  months). 

Cases  where  earning  power  will  not  be  considered. — Cor- 
porations that  have  no  regular  earnings,  such  as  com- 
panies organized  for  the  purpose  of  developing  and  sell- 
ing timber  land,  mining  property,  and  other  real  prop- 

i  To  the  average  business  man  it  may  seem  a  paradox  to  say  there  is 
such  a  thing  as  a  fair  value  of  capital.  To  him  a  dollar  is  worth  a  dollar. 
But  the  fact  remains  that  from  the  investment  point  of  view  a  dollar  may 
be  worth  more  than  a  dollar.  The  dollar  that  earns  20  cents  a  year  is 
worth  twice  as  much  as  the  dollar  that  earns  only  10  cents. 


374        INCOME   AND   FEDERAL    TAX   REPORTS 

erty  (including  real  estate),  and  corporations  that  have 
earned  no  profits  in  the  past  five  years  or  have  only 
been  engaged  in  business  one  or  two  years,  cannot  well 
estimate  the  value  of  the  stock  from  their  earning  ca- 
pacity. They  are  permitted  to  estimate  the  fair  value 
of  the  stock  from  the  book  value,  and  should  attach  a 
detailed  balance  sheet  as  of  the  close  of  the  fiscal  year 
to  the  back  of  the  return. 

Fictitious  book  values. — If  the  book  value  is  fictitious, 
and  is  the  result  of  overestimating  the  assets,  this  fact 
should  be  fully  explained,  either  on  the  return  or  in  a 
statement  attached  to  the  return. 

Value  of  stock  of  subsidiaries. — Where  a  holding  com- 
pany owns  all  the  stock  of  several  subsidiaries,  which 
stock  is  not  listed  on  any  exchange  or  has  not  been  sold 
in  the  last  fiscal  year,  it  has  been  held  that  the  fair 
value  of  the  stock  of  such  subsidiary  companies  may  be 
estimated  from  the  market  value  of  the  total  capital 
stock  of  the  holding  company  (the  parent  corpora- 
tion). 

The  fair  value  of  the  total  capital  stock  of  the  parent 
company  is  generally  computed  under  Cases  I  or  II, 
and  therefore  this  amount  may  be  divided  among  the 
subsidiaries  in  proportion  to  the  total  amount  of  net 
profits  earned  by  the  subsidiaries  plus  the  amount  of 
net  profits  earned  by  the  parent  company  from  actual 
operations  and  investments  or  holdings  of  stock  in 
other  companies. 

Preferred  and  common  stock  under  Case  III. — Where 
there  is  more  than  one  class  of  stock  there  is  no  pro- 
vision under  Case  III  for  arriving  at  the  fair  value  per 
share  of  each  class  separately,  and  therefore  the  earn- 
ings should  be  based  on  the  total  number  of  shares  out- 
standing, giving  an  average  fair  value  per  share  irre- 
spective of  the  class  of  stock.  This  fair  value  will  be 
multiplied  by  the  total  number  of  shares  outstanding, 
in  order  to  arrive  at  the  total  fair  value. 


CAPITAL   STOCK    TAX  375 

Basis  of  tax  for  foreign  corporations. — Foreign  corpora- 
tions are  taxed  on  the  basis  of  the  average  amount  of 
capital  actually  invested  in  the  transaction  of  business 
in  the  United  States  during  the  preceding  fiscal  year, 
with  the  provision  that  deposits  or  reserve  funds  main- 
tained or  held  in  the  United  States  by  insurance  com- 
panies under  the  requirements  of  law  or  contract  for 
the  protection  of  or  payment  to  or  apportionment  among 
policyholders  shall  be  deducted. 

Any  surplus  or  undivided  profits  invested  in  United 
States  bonds  or  other  securities  which  have  no  connec- 
tion whatever  with  the  actual  business  of  the  corpora- 
tion transacted  in  this  country  will  not  be  considered 
as  capital  invested  in  the  United  States  for  the  purpose 
of  the  tax. 

Bank  balances  carried  in  the  United  States  should  be 
considered  as  capital  in  the  United  States  if  they  are 
treated  as  such  upon  the  books  of  the  company. 

The  corporation  may  state  on  its  return  the  amount 
of  capital  invested  outside  of  the  United  States  and 
deduct  such  proportion  of  $99,000  as  the  capital  in- 
vested in  the  United  States  bears  to  the  total  capital 
both  here  and  abroad. 

Foreign  insurance  companies  may  state  the  amount 
of  "surplus  to  policyholders"  as  shown  by  the  conven- 
tional form  of  report  to  State  insurance  departments, 
for  the  fiscal  year  ended  December  31st.  In  this  case 
the  only  deduction  allowed  is  the  amount  of  deposits 
actually  required  by  States  in  which  the  company  is 
transacting  business. 

Rate  and  computation  of  tax  for  United  States  corpora- 
tions.— The  tax  is  at  the  rate  of  50  cents  on  each  full 
one  thousand  dollars  of  fair  value  of  the  capital  stock 
in  excess  of  ninety-nine  thousand  dollars. 

When  an  inactive  corporation  resumes  business  the 
tax  will  be  computed  proportionately  from  the  first  day 
of  the  month  in  which  it  resumes  business  to  the  end  of 


376  INCOME    AND    FEDERAL    TAX    REPORTS 

the  fiscal  year.  A  corporation  resuming  business  in 
August  would  be  taxed  at  the  rate  of  45.83  cents  instead 
of  50  cents  per  thousand  dollars. 

Domestic  insurance  corporations  are  not  permitted  to 
deduct  reserves  and  deposits  maintained  or  held  in  the 
United  States  for  the  protection  of,  or  payment  to,  or 
apportionment  among  policyholders,  as  such  reserves 
and  deposits  are  reflected  in  the  fair  value  of  the  stock 
as  computed  under  Cases  I,  II  and  III. 

The  amount  actually  paid  for  munitions  tax  during 
the  preceding  fiscal  year  should  be  deducted  from  the 
amount  of  the  tax. 

No  deductions  are  allowed  United  States  corporations 
for  capital  invested  in  foreign  countries. 

Rate  and  computation  of  the  tax  for  foreign  corporations. 
— The  tax  is  at  the  rate  of  50  cents  on  each  full  one 
thousand  dollars  of  capital  invested  in  the  transaction 
of  business  in  the  United  States.  The  amount  of  cap- 
ital invested  in  the  United  States  is  subject  to  two  de- 
ductions: (1)  the  allowable  proportion  of  $99,000;  (2) 
the  amount  of  reserves  and  deposits  maintained  or  held 
in  the  United  States  by  insurance  companies  as  required 
by  law  or  contract. 

The  amount  actually  paid  for  munitions  tax  during 
the  preceding  fiscal  year  should  be  deducted  from  the 
amount  of  the  tax. 

Returns  due  annually  in  July. — All  corporations  re- 
quired to  file  returns  should  file  them  annually  in  July, 
with  the  Collector  of  Internal  Revenue  for  the  district 
in  which  the  principal  place  of  business  of  the  corpora- 
tion is  located. 

Returns  may  be  made  by  Collector. — If  any  corporation 
fails  to  make  a  return  at  the  time  prescribed  by  law,  or 
makes  a  false  or  fraudulent  return,  the  collector  or 
deputy  collector  shall  make  the  return  or  list  from  his 
own  knowledge  and  from  such  information  as  he  can 
obtain  through  testimony  or  otherwise.    Any  return  or 


CAPITAL   STOCK   TAX  377 

list  so  made  and  subscribed  by  a  collector  or  deputy 
collector  shall  be  prima  facie  good  and  sufficient  for  all 
legal  purposes. 

Forms  are  supplied  by  the  Government,  but  failure  to  re- 
ceive forms  does  not  relieve  from  penalty. — Forms  will  be 
sent  to  all  taxable  corporations  known  to  the  collectors, 
but  failure  to  receive  a  blank  form  does  not  relieve  a 
corporation  from  the  penalties  prescribed  for  failure  to 
make  returns  within  the  time  required. 

Extension  of  time. — If  the  failure  to  file  a  return  or 
list  is  due  to  sickness  or  absence  of  an  officer  required 
to  sign  the  return,  the  collector  may  allow  an  extension 
of  not  more  than  thirty  days  from  July  31  in  which  to 
file  the  return. 

Form  of  return  for  domestic  corporations. — Domestic 
corporations  are  required  to  make  returns  upon  Form 
707,  and  foreign  corporations  upon  Form  708. 

Form  707  requires  the  following  information: 

1.  Kind  of  business. 

2.  Par  value  of  common  stock. 

3.  Par  value  of  preferred  stock. 

4.  Total  value  of  capital  stock. 

5.  Amount  of  surplus. 

6.  Amount  of  undivided  profits. 

The  figures  given  in  answer  to  questions  5  and  6 
should  be  as  of  the  date  of  the  return,  but  if  these 
figures  cannot  be  obtained,  those  of  the  end  of  the 
last  calendar  or  fiscal  year  of  the  corporation  may  be 
used. 

7.  Average  fair  value  per  share,  to  be  computed 

as  indicated  in  any  of  the  three  cases. 
Under  Case  III  the  "average  dividends  per  share  paid 
during  preceding  five  years"  is  required.  This  is  only 
for  the  information  of  the  office  of  the  collector  of  in- 
ternal revenue  in  a  case  where  a  corporation  shows  an 
earning  capacity  but  does  not  state  any  surplus  or  un- 
divided profits. 


378  INCOME    AND    FEDERAL    TAX    REPORTS 

8.  Number  of  shares  of  common  stock  outstand- 

ing June  30,  multiplied  by  average  value  per 
share  as  arrived  at  under  No.  7,  giving  total 
fair  value  of  common  stock. 

9.  Number  of  shares  of  preferred  stock  outstand- 

ing June  30,  multiplied  by  average  value  per 
share  as  arrived  at  under  No.  7,  giving  total 
fair  value  of  preferred  stock. 

10.  Fair  value  of  total  capital  stock  for  preceding 

fiscal  year  ended  June  30,  the  sum  of  8 
and  9. 

11.  Deduction  allowed  by  law— $99,000. 

12.  Amount  of  fair  value  of  stock  over  $99,000. 

13.  Tax  at  rate  of  50  cents  per  year  for  each  full 

$1,000. 

14.  Deduction  of  amount  of  munitions  tax  paid. 

15.  Amount  of  tax  due. 

This  return  must  be  signed  and  sworn  to  by  two  offi- 
cers of  the  corporation  before  an  officer  authorized  to 
administer  oaths,  and  the  seal  of  the  attesting  officer,  if 
he  is  required  to  have  a  seal,  must  be  impressed  on  the 
return. 

Form  of  return  for  foreign  corporations. — Form  708,  for 
foreign  corporations,  requires  the  following  informa- 
tion: 

1.  Kind  of  business. 

2.  Capital  invested  in  the  United  States.     (This 

should  be  the  average  amount  invested  dur- 
ing the  year.) 

3.  Capital  invested  in  foreign  countries.    The  law 

does  not  require  this  to  be  the  average  cap- 
ital invested.  The  figure  used  may  be  either 
that  of  June  30th  or  of  the  end  of  the  fiscal 
year  of  the  corporation. 

4.  Total  capital  invested  by  the  corporation  both 

in  the  United  States  and  elsewhere  —  the 
sum  of  2  and  3. 


CAPITAL    STOCK    TAX  379 

5.  Amount    of    capital    invested    in    the    United 

States  (brought  down  from  Item  2  above), 
and  percentage  of  total  capital  invested  in 
the  United  States. 

6.  Deductions  allowed  by  law. 

(1)  Reserves  and  deposits  of  insurance  com- 
pany. 

(2)  Proportion  of  $99,000. 

7.  Amount  of  capital  on  which  tax  should  be  com- 

puted. 

8.  Tax  at  rate  of  50  cents  per  year. 

9.  Deduction  of  munitions  tax  paid. 
10.  Amount  of  tax  due. 

This  return  must  be  signed  and  verified  by  the  agent 
or  attorney,  or  other  principal  officer  in  charge  of  the 
United  States  branch  of  the  foreign  corporation,  and 
must  be  sworn  to  before  an  officer  authorized  to  admin- 
ister oaths,  and  the  seal  of  the  attesting  officer,  if  he  is 
required  to  have  a  seal,  must  be  impressed  on  the  re- 
turn. 

Tax  payable  when  notice  of  assessment  has  been  given. — 
The  tax  may  be  paid  at  the  time  of  filing  or  at  any 
time  subsequent,  but  no  penalty  will  be  attached  until 
assessment  is  made  and  ten  days'  notice  given  and  de- 
mand made  on  the  official  form  (Form  17)  for  the  tax. 

Payment  may  be  made  in  cash  or  by  certified  check. 

Receipts  need  not  be  displayed. — The  corporation  will 
receive  a  receipt  as  evidence  of  the  payment  of  the  tax, 
but  will  not  be  required  to  display  same  as  if  it  were  a 
special  stamp  tax. 

Penalty  for  failure  to  file  return. — In  case  of  failure  to 
make  and  file  a  return  within  the  time  prescribed  by 
law,  there  shall  be  added  to  the  tax  50%  of  its  amount, 
and  the  corporation  shall  be  liable  to  a  fine  of  not  more 
than  $500. 

Subsequent  voluntary  returns. — Should  a  return  be  filed 
voluntarily  after  the  time  required  by  the  law,  without 


380  INCOME   AND   FEDERAL    TAX   REPORTS 

notice  from  the  collector,  no  50%  penalty  will  attach  if 
it  is  shown  that  the  failure  to  file  the  return  was  due 
to  a  reasonable  cause  and  not  to  wilful  neglect. 

Penalty  for  false  or  fraudulent  return. — In  case  a  false 
or  fraudulent  return  or  list  is  wilfully  made,  the  Com- 
missioner of  Internal  Eevenue  shall  add  to  the  tax  one 
hundred  per  centum  of  its  amount. 

Penalty  for  failure  to  pay  tax  when  due. — Upon  failure 
to  pay  the  tax  assessed  within  ten  days  after  notice  and 
demand,  a  penalty  of  5  per  cent  of  the  tax  unpaid  and 
interest  at  the  rate  of  1  per  cent  per  month  until  paid 
shall  be  added  to  the  amount  of  such  tax. 

Specific  penalty  for  failure  to  pay  tax. — Section  408, 
Title  IV,  of  the  Act  of  September  8,  1916,  provides  that 
every  person  who  carries  on  any  business  or  occupation 
for  which  special  taxes  are  imposed  by  this  title,  with- 
out having  paid  the  special  tax  therein  provided,  shall, 
besides  being  liable  to  the  payment  of  such  special  tax, 
be  deemed  guilty  of  a  misdemeanor,  and  upon  conviction 
thereof  shall  pay  a  fine  of  not  more  than  $500  or  be 
imprisoned  not  more  than  six  months,  or  both,  in  the 
discretion  of  the  court. 


CHAPTER  XV 
CAPITAL  STOCK  TAX  LAW 

BEING  TITLE  IV  OF  "AN  ACT  TO  INCREASE  THE 

REVENUE  AND  FOR  OTHER  PURPOSES," 

APPROVED  SEPTEMBER  8,  1916  (PUBLIC 

—NO.  271— 64th  CONGRESS)  IN  EFFECT 

SEPTEMBER  9,  1916. 


Excise  tax  on  domestic  and  foreign  corporations. — Sec. 
407.  That  on  and  after  January  firstj  nineteen  hundred 
and  seventeen,  special  taxes  shall  be,  and  hereby  are, 
imposed  annually,  as  follows,  that  is  to  say:  Every 
corporation,  joint-stock  company  or  association,  now  or 
hereafter  organized  in  the  United  States  for  profit  and 
having  a  capital  stock  represented  by  shares,  and  every 
insurance  company,  now  or  hereafter  organized  under 
the  laws  of  the  United  States,  or  any  State  or  Terri- 
tory of  the  United  States,  shall  pay  annually  a  spe- 
cial excise  tax  with  respect  to  the  carrying  on  or 
doing  business  by  such  corporation,  joint-stock  company 
or  association,  or  insurance  company,  equivalent  to 
fifty  cents  for  each  $1,000  of  the  fair  value  of  its  cap- 
ital stock  and  in  estimating  the  value  of  capital  stock 
the  surplus  and  undivided  profits  shall  be  included: 
Provided,  That  in  the  case  of  insurance  companies  such 
deposits  and  reserve  funds  as  they  are  required  by  law 
or  contract  to  maintain  or  hold  for  the  protection  of  or 
payment  to  or  apportionment  among  policyholders  shall 
not  be  included.  The  amount  of  such  annual  tax  shall 
in  all  cases  be  computed  on  the  basis  of  the  fair  aver- 

381 


382  INCOME    AND    FEDERAL    TAX    REPORTS 

age  value  of  the  capital  stock  for  the  preceding  year: 
provided,  That  for  the  purpose  of  this  tax  an  exemption 
of  $99,000  shall  be  allowed  from  the  capital  stock  as  de- 
fined in  this  paragraph  of  each  corporation,  joint-stock 
company  or  association  or  insurance  company.  And 
provided  further,  That  a  corporation,  joint-stock  com- 
pany or  association,  or  insurance  company,  actually 
paying  the  tax  imposed  by  section  three  hundred  and 
one  of  Title  III  [Munition  Manufacturer's  Tax]  of  this 
Act  shall  be  entitled  to  a  credit  as  against  the  tax  im- 
posed by  this  paragraph  equal  to  the  amount  of  the  tax 
so  actually  paid:  And  provided  further,  That  this  tax 
shall  not  be  imposed  upon  any  corporation,  joint-stock 
company  or  association,  or  insurance  company  not  en- 
gaged in  business  during  the  preceding  taxable  year,  or 
which  is  exempt  under  the  provisions  of  section  eleven, 
Title  I,  of  this  Act. 

Every  corporation,  joint-stock  company  or  associa- 
tion, or  insurance  company,  now  or  hereafter  organized 
for  profit  under  the  laws  of  any  foreign  country  and 
engaged  in  business  in  the  United  States,  shall  pay  an- 
nually a  special  excise  tax  with  respect  to  the  carrying 
on  or  doing  business  in  the  United  States  by  such  cor- 
poration, joint-stock  company  or  association,  or  insur- 
ance company,  equivalent  to  50  cents  for  each  $1,000 
of  the  capital  actually  invested  in  the  transaction  of  its 
business  in  the  United  States:  Provided,  That  in  the 
case  of  insurance  companies  such  deposits  or  reserve 
funds  as  they  are  required  by  law  or  contract  to  main- 
tain or  hold  in  the  United  States  for  the  protection  of 
or  payment  to  or  apportionment  among  policyholders 
shall  not  be  included.  The  amount  of  such  annual  tax 
shall  in  all  cases  be  computed  on  the  basis  of  the  aver- 
age amount  of  capital  so  invested  during  the  preceding 
year:  Provided,  That  for  the  purpose  of  this  tax  an 
exemption  from  the  amount  of  capital  so  invested  shall 
be  allowed  equal  to  such  proportion  of  $99,000  as  the 


CAPITAL    STOCK    TAX    LAW  383 

amount  so  invested  bears  to  the  total  amount  invested 
in  the  transaction  of  business  in  the  United  States  or 
elsewhere:  Provided  further,  That  this  exemption 
shall  be  allowed  only  if  such  corporation,  joint-stock 
company,  or  association,  or  insurance  company  makes 
return  to  the  Commissioner  of  Internal  Revenue,  under 
regulations  prescribed  by  him,  with  the  approval  of  the 
Secretary  of  the  Treasury,  of  the  amount  of  capital  in- 
vested in  the  transaction  of  business  outside  the  United 
States:  And  pro\ided  further,  That  a  corporation, 
joint-stock  company  or  association,  or  insurance  com- 
pany, actually  paying  the  tax  imposed  by  section  301  of 
Title  III  [Munition  Manufacturer's  Tax]  of  this  act, 
shall  be  entitled  to  a  credit  as  against  the  tax  imposed 
by  this  paragraph  equal  to  the  amount  of  the  tax  so  ac- 
tually paid:  And  provided  further,  That  this  tax  shall 
not  be  imposed  upon  any  corporation,  joint-stock  com- 
pany or  association,  or  insurance  company  not  engaged 
in  business  during  the  preceding  taxable  year,  or  which 
is  exempt  under  the  provisions  of  section  eleven,  Title 
I,  of  this  act. 

Penalties  for  evasion  of  tax. — Every  person  who  car- 
ries on  any  business  or  occupation  for  which  special 
taxes  are  imposed  by  this  title,  without  having  paid 
the  special  tax  therein  provided,  shall,  besides  being 
liable  to  the  payment  of  such  special  tax,  be  deemed 
guilty  of  a  misdemeanor,  and  upon  conviction  thereof 
shall  pay  a  fine  of  not  more  than  $500,  or  be  imprisoned 
not  more  than  six  months,  or  both,  in  the  discretion  of 
the  court. 

Administrative  provisions.  —  Sec.  409.  That  all  ad 
ministrative  or  special  provisions  of  law,  including  the 
law  relating  to  the  assessment  of  taxes,  so  far  as  ap- 
plicable, are  hereby  extended  to  and  made  a  part  of 
this  title,  and  every  person,  firm,  company,  corpora- 
tion, or  association  liable  to  any  tax  imposed  by  this 
title,  shall  keep  such  records  and  render,  under  oath. 


384        INCOME   AND   FEDERAL    TAX   REPORTS 

such  statements  and  returns,  and  shall  comply  with  such 
regulations  as  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury, 
may  from  time  to  time  prescribe. 

Approved  by  the  President,  September  8,  1916. 


CHAPTER  XVI 

FEDERAL  INHERITANCE  OR 
ESTATE  TAX 


INTRODUCTION 


Origin  of  inheritance  taxes. — A  little  less  than  a  decade 
ago  inheritance  taxes  were  practically  unknown  in  the 
United  States.  They  are,  however,  of  ancient  origin. 
Historians  tell  us  that  over  two  thousand  years  ago  they 
were  imposed  by  the  Romans,  where,  perhaps,  the  idea 
had  been  introduced  from  Egypt,  while  in  the  Middle 
Ages  it  seems  they  existed  as  an  incident  of  feudal  ten- 
ures. Today  practically  every  civilized  nation  has 
adopted  some  system  of  inheritance  taxation,  while  in 
the  United  States  all  but  five  States  *  have  enacted  such 
laws. 

Inheritance  taxes  in  the  United  States. — As  a  means  of 
contributing  to  the  income  of  the  Federal  Government, 
inheritance  taxes  are  not  new.  The  first  tax  of  this 
nature  was  imposed  by  the  Stamp  Act  of  July  6,  1797, 
which  was  repealed  five  years  later.  The  War  Rev- 
enue Act  of  July  1,  1862,  included  an  inheritance  tax, 
which  remained  in  force  until  July  14,  1870.  Although 
the  income  tax  provisions  of  the  Revenue  Act  of  August 
27,  1894,  embraced  inheritances,  the  scheme  failed,  when 
the  law  was  declared  unconstitutional.  The  next  in- 
heritance tax  law  passed  by  Congress  was  the  War 
Revenue  Act  of  June  13,  1898,  which,  so  far  as  the  in- 
heritance feature  is  concerned,  was  repealed  April  12, 

i  Ala.,  Fla.,  Miss.,  N.  Mex.,  and  S.  Car. 

385 


386  INCOME   AND    FEDERAL    TAX    REPORTS 

1902.  Finally,  on  September  8,  1916,  the  national  leg- 
islature passed  an  "Act  to  Increase  the  Eevenue  and 
for  Other  Purposes,"  imposing  an  "estate"  tax  on  the 
property  of  resident  and  non-resident  decedents  alike, 
which  has  twice  been  amended  for  the  purpose  of  in- 
creasing the  rates. 

Earlier  laws  were  emergency  measures. — Prior  to  Sep- 
tember 8,  1916,  inheritance  taxes  were  adopted  by  the 
Federal  Government  as  an  emergency  measure,  as  was 
done  subsequent  to  the  Eevolutionary  War  and  during 
the  Civil  and  the  Spanish-American  Wars,  while  it 
seems  to  have  been  taken  for  granted  that,  in  normal 
times  at  least,  this  method  of  raising  money  should  be 
left  to  the  States.  The  new  law,  however,  was  passed 
at  a  time  when  we  were  at  peace  and  enjoying  unusual 
prosperity.  Does  it  herald  the  era  when  all  inheritance 
taxation  will  be  reserved  exclusively  to  the  Federal 
Government,  while  the  States  merely  will  participate  in 
the  proceeds? 

The  Act  of  September  8,  1916. — Unlike  most  inheritance 
tax  laws,  the  Act  of  September  8,  1916,  imposes  a  tax 
on  the  entire  net  estate,  instead  of  on  each  distributive 
share.  The  law  also  requires  the  executor,  under  cer- 
tain conditions,  to  file  a  notice  with  the  Collector  of 
Internal  Revenue  within  thirty  days  after  qualifying  or 
coming  into  possession  of  property  of  the  decedent,  and 
to  file  a  return  and  to  pay  the  tax  on  or  before  one  year 
after  the  death  of  the  decedent.  In  some  instances, 
donees,  beneficiaries,  heirs,  trustees,  fiduciaries,  trans- 
fer and  paying  agents  and  registrars  must  file  the  no- 
tice, make  the  return  and  pay  the  tax.  A  penalty  of 
$500  is  imposed  where  the  notice  or  the  return  is  not 
filed  on  time,  and  for  making  any  false  statement  a  fine 
of  $5,000,  with  perhaps  imprisonment. 

As  mentioned  above,  the  original  "estate"  tax  law 
passed  September  8,  1916,  has  been  amended  twice  for 
the  purpose  of  increasing  the  rates.     The  rates  pro- 


FEDERAL   INHERITANCE    OR    ESTATE    TAX  387 

vided  in  the  original  act  apply  to  the  net  estate  of  every 
decedent  dying  on  and  after  September  9,  1916,  to  and 
including  March  2,  1917.  The  rates  provided  in  the 
first  amendment  apply  to  the  net  estate  of  every  de- 
cedent dying  on  and  after  March  3,  1917,  to  and  includ- 
ing October  3,  1917.  The  rates  provided  in  the  second 
amendment  apply  to  the  net  estate  of  every  decedent 
dying  on  and  after  October  4,  1917  (except  where  the 
decedent  died  while  serving  in  the  military  or  naval 
forces  of  the  United  States,  during  the  continuance  of 
the  war  in  which  the  United  States  is  now  engaged,  or 
if  decedent  died  from  injuries,  or  disease,  while  in  the 
service,  within  one  year  after  the  termination  of  the 
war). 

The  administration  of  the  law  is  governed  by  regula- 
tions and  decisions  issued  by  the  Treasury  Department. 

In  the  succeeding  paragraphs  there  have  been  defined 
the  duties  of  executors,  administrators  and  others,  as 
required  by  the  law,  regulations  and  treasury  decisions 
issued  to  date  of  publication  of  this  book. 

DEFINITIONS  OF  TERMS 

Several  terms  are  used  in  the  law  and  regulations, 
which,  in  addition  to  their  common  import,  have  been 
assigned  special  meanings.  It  is  thought  best,  there- 
fore, to  define  their  exact  meaning  under  the  law. 

Collector. — This  term  means  the  collector  of  inter- 
nal revenue  of  the  district  in  which  the  decedent 
maintained  his  legal  residence  at  the  time  of  his  death. 
If  the  decedent  resided  outside  of  the  United  States, 
then  the  term  "collector"  means  the  collector  of  the 
district  in  which  is  located  the  decedent's  property. 
If  a  non-resident  decedent  leaves  property  in  more  than 
one  district,  then  the  term  means  the  collector  at  Bal- 
timore, Maryland. 

The  Act  does  not  distinguish  between  citizens   and 


388  INCOME   AND   FEDERAL    TAX    REPORTS 

aliens,  but  does  distinguish  between  residents  and  non- 
residents of  the  United  States  at  the  time  of  their 
death.  If  a  citizen  of  the  United  States ■  has  main- 
tained his  principal  domicile  abroad  prior  to  his  death, 
his  estate  is  taxable  as  that  of  a  non-resident. 

Executor. — This  term  includes  an  executor,  or  admin- 
istrator, of  the  estate  of  a  decedent.  If  there  is  no 
executor  or  administrator,  the  term  nevertheless  in- 
cludes any  person  having  or  coming  into  possession  of 
property  of  the  decedent. 

Exemption. — This  term  means  the  $50,000  specific 
exemption  permitted  to  be  deducted  from  the  gross  es- 
tate in  determining  the  amount  of  the  net  estate  of  a 
resident  decedent,  whether  citizen  or  alien  of  the  United 
States.  (See  "Net  Estate.")  (Law— Sec.  203;  Reg.— 
Art.  20.) 

Gross  Estate. — This  term  includes  all  property,  both 
real  and  personal,  tangible  or  intangible,  wherever  sit- 
uated at  the  time  of  a  resident  decedent's  death ;  and  all 
property  situated  in  the  United  States  at  the  time  of 
a  non-resident  decedent's  death.  It  also  includes  any 
transfer,  either  in  trust  or  otherwise,  of  property,  ex- 
cept for  a  fair  consideration  in  money  or  money's 
worth,  effected  by  a  taxable  decedent  at  any  time  dur- 
ing his  life  but  in  contemplation  of  death,  regardless 
of  whether  the  transfer  was  fully  effected  or  the  instru- 
ment of  transfer  executed  before  or  after  the  passage 
of  the  taxing  act  of  September  8,  1916. 

It  has  been  held  that  the  language  of  the  Act  is  so 
specific  that  it  was  clearly  the  intent  of  Congress  "to 
include  not  only  such  transfers,  including  gifts  and 
sales  not  bona  fide,  made  by  instrument  dated  after 

i  The  term  United  States  means  only  the  States,  the  Territories  of 
Alaska  and  Hawaii  and  the  District  of  Columbia.  The  tax  is  not  imposed 
in  Porto  Rico,  the  Philippine  or  Virgin  Islands,  but  the  property  in  the 
United  States  of  deceased  residents  of  these  islands  is  taxable  as  the 
property  of  non-residents. 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  389 

September  8,  1916,  or  when  the  actual  transfer  took 
place  after  that  date,  but  transfers  of  any  kind  made 
in  contemplation  of  death  at  any  time  whatsoever  prior 
to  September  8,  1916.  It  is  believed  also  that  there  is 
no  question  of  the  power  of  Congress  to  enact  such 
revenue  legislation.  The  test  of  the  tax  liability  is  not 
in  such  cases  the  date  of  the  instrument  making  the 
transfer,  or  the  date  of  the  actual  transfer,  but  the  date 
of  the  death  of  the  decedent." 

The  term  includes  the  interest  of  the  decedent  in  any 
property  held  jointly  by  the  decedent  and  any  other 
person,  or  deposited  in  banks  or  otherwise.  It  does  not 
include  the  interest  which  a  decedent  had  in  property 
devised  to  him  for  life  only,  with  the  remainder  vested 
in  another.  But  a  vested  remainder  in  property,  sub- 
ject to  a  life  tenancy,  should  be  included  in  gross  es- 
tate. This  is  for  the  reason  that  the  estate  tax  is  based 
upon  the  actual  value  of  the  interest  of  the  decedent 
at  the  time  of  death.  The  value  of  the  vested  remain- 
der is  computed  by  reference  to  mortality  tables. 

In  computing  the  value  of  the  gross  estate  no  pro- 
vision is  made  for  the  deduction  of  the  widow's  dower 
or  husband's  curtesy. 

Gross  estate  also  includes  accrued  interest  on  securi- 
ties, and  accrued  dividends  on  preferred  stock,  if  fixed 
and  certain,  to  the  day  of  death,  and  all  other  divi- 
dends that  were  declared  prior  to  the  day  of  death. 
Income  of  the  estate  and  appreciation  of  values  after 
death  are  excluded. 

All  insurance,  not  payable  directly  to  a  beneficiary 
named  in  the  policy,  is  included,  also  any  accrued  divi- 
dends. 

All  property  over  which  decedent  exercised  his  power 
of  appointment  is  also  included. 

Stock  in  a  domestic  corporation  and  held  by  a  non- 
resident decedent  is  a  part  of  the  gross  estate,  and  is 
deemed  property  within  the  United  States,  even  though 


390  INCOME   AND    FEDERAL    TAX    REPORTS 

actually  situated  outside  the  United  States  at  the  time 
of  decedent's  death. 

Gross  estate  does  not  include  any  bonds  of  domestic 
corporations  owned  by  a  non-resident  physically  located 
outside  the  United  States  at  the  time  of  his  death. 
However,  a  tax  is  imposed  upon  the  value  of  bonds, 
both  foreign  and  domestic,  owned  by  a  non-resident 
decedent  which  bonds  were  physically  situate  in  the 
United  States,  Hawaii  or  Alaska  at  the  time  of  the 
owner's  death,  and  the  value  of  such  bonds  must  be  in- 
cluded as  a  portion  of  his  gross  estate. 

Bonds,  both  foreign  or  domestic,  owned  by  a  resident 
decedent  are  taxable  regardless  of  where  such  bonds 
are  situated  at  the  time  of  the  owner's  death. 

The  value  of  United  States  and  other  "tax  exempt" 
bonds  owned  by  the  decedent  is  a  part  of  the  gross 
estate. 

One-half  of  the  value  of  so-called  "community  prop- 
erty" *  should  be  included  in  the  gross  estate  of  the 
decedent  husband  or  wife.  If  the  survivor's  interest  be 
that  merely  of  dower  or  curtesy,  then  the  whole  value 
of  the  "community  property"  is  to  be  included  in  the 
gross  estate  of  the  decedent. 
Household  goods  and  other  miscellaneous  personalty 
of  like  nature  used  by  husband  and  wife  in  the  mar- 
riage relation  are  presumed  to  be  the  property  of  the 
husband  and  must  be  included  in  his  gross  estate.  If 
the  widow  claims  any  part  as  her  separate  property 
she  must  furnish  evidence  showing  that  such  articles 
were  (1)  owned  by  her  prior  to  marriage;  or  (2)  pur- 
chased out  of  her  separate  funds;  or  (3)  acquired  by 
gift  or  inheritance  to  her  direct. 

i  In  Texas,  and  in  a  few  other  States,  all  property  earned  or  acquired 
by  purchase  or  by  gift  (with  one  or  two  exceptions)  by  a  husband  or 
wife  during  the  period  of  their  marriage,  is  termed  "community  property." 
Such  property  is  owned  jointly  by  the  husband  and  wife,  and  upon  the 
death  of  either,  the  title  thereto  vests  absolutely  in  the  survivor.  A 
similar  condition  exists  in  Pennsylvania,  respecting  real  property,  in  cases 
where  the  convevance  is  made  to  both  the  husband  and  wife. 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  391 

The  value  of  loans  evidenced  by  promissory  notes  is 
to  be  included  in  the  gross  estate,  even  though  by  will 
the  decedent  provides  that  the  notes  shall  be  cancelled. 

The  gross  value  of  mortgaged  property  must  be 
shown  in  the  gross  estate,  and  the  amount  of  the  mort- 
gage treated  as  a  deduction.  Thus,  if  a  decedent's  es- 
tate consists  exclusively  of  real  property  valued  at 
$75,000,  against  which  there  is  a  mortgage  of  $40,000, 
the  gross  estate  must  be  reported  at  $75,000,  even 
though  the  equity  of  the  decedent  is  but  $35,000. 

Net  Estate. — "Net  estate"  means  that  portion  of  the 
gross  estate  remaining  after  deductions  for  the  follow- 
ing have  been  made: 

(a)  Resident's  Estate: 

(1)  Funeral  expenses;  administration  expenses,  in- 
cluding the  executor's  and  attorney's  fees  and  miscel- 
laneous expenses,  but  excluding  all  State  inheritance 
taxes;  claims  against  the  estate,  including  mortgages 
and  debts  of  the  decedent;  losses  arising  from  fires, 
storms,  shipwreck,  or  other  casualty,  and  from  theft 
during  administration  and  not  compensated  for  by  in- 
surance or  otherwise;  support  during  settlement  of  the 
estate  of  those  actually  dependent  upon  the  decedent; 
and  such  other  charges,  if  any,  as  are  allowed  by  the 
local  laws  under  which  the  estate  is  being  administered. 

(2)  A  specific  exemption  of  $50,000. 

(b)  Non-Resident's  Estate: 

Such  a  proportion  of  the  items  specified  in  section 
(a),  subdivision  1,  above,  as  the  proportion  of  de- 
cedent's property  located  within  the  United  States  bears 
to  the  total  amount  of  decedent's  property  wherever 
situated,  provided  the  executor  includes  in  the  return 
required  to  be  filed  the  value  at  the  time  of  his  death  of 
that  part  of  the  gross  estate  of  the  non-resident  not 
situated  in  the  United  States. 

The   specific   exemption   of   $50,000,   or   any  portion 


392  INCOME    AND    FEDERAL    TAX    REPORTS 

thereof,  allowed  to  a  resident  decedent's  estate  is  not 
allowed  a  non-resident  decedent's  estate. 

It  should  be  noted  that  no  claim  for  deduction  will 
be  allowed  unless  the  amount  claimed  has  been  actually 
expended,  and  is  within  the  statutory  limitation,  if  any, 
of  the  local  jurisdiction. 

Amounts  paid  for  the  support  of  dependents  will  not 
be  allowed  as  a  deduction  unless  all  and  each  of  the 
following  conditions  exist: 

1.  There  must  be  an  actual  expenditure  of  money 

— not  merely  its  equivalent; 

2.  The  persons  for  whose  support  the  money  is  ex- 

pended must  be  actually  dependent  upon  the 
deceased — if  they  have  independent  means,  the 
claim  will  not  be  allowed. 

3.  The  amount  actually  expended  must  not  exceed 

the  limit  set  by  the  local  laws  under  which  the 
estate  is  being  administered. 

Losses  sustained  through  sale  of  assets  at  less  than 
the  inventory  value  are  not  allowed  as  a  deduction. 

In  the  schedule  of  assets  of  a  certain  estate  the 
stocks  and  bonds  owned  by  the  decedent  at  time  of 
death  were  inventoried  at  $388,000,  and  during  the  ad- 
ministration of  the  estate  all  were  sold  to  raise  the  nec- 
essary cash  to  pay  pecuniary  legacies  and  taxes.  The 
amount  realized  from  the  sale  was  $361,000,  so  that 
there  was  a  determined  loss  to  the  corpus  of  the  es- 
tate of  $27,000,  arising  from  the  necessity  of  adminis- 
tration. It  was  stated  that  the  executor  had  used  his 
best  judgment  in  making  sales,  but  due  to  the  state  of 
the  security  market  it  was  impossible  to  realize  on  even 
the  most  gilt-edged  securities  without  taking  some  loss 
from  quotations  on  the  market  at  the  date  of  the  de- 
cedent's death.  Under  these  circumstances  it  was 
argued  this  loss  to  the  estate  should  be  included  among 
the  deductions  from  the  gross  estate  allowed  in  com- 


FEDERAL   INHERITANCE    OR    ESTATE    TAX  393 

puting  the  tax;  also,  that  inasmuch  as  the  purpose  of 
making  these  sales  was  to  provide  for  the  payment  of 
pecuniary  legacies  and  of  the  State  and  Federal  taxes, 
the  loss  so  sustained  should  be  allowed  either  under 
"Administration  expenses"  or  "Determined  losses  dur- 
ing administration."  The  Treasury  Department  held: 
"The  value  of  securities  as  of  the  date  of  decedent's 
death  should  be  returned  as  a  portion  of  his  gross  es- 
tate. Any  subsequent  depreciation  or  appreciation  is 
not  considered  for  Federal  Estate  Tax  purposes.  Losses 
occurring  during  administration  which  are  deductible 
are  set  out  in  Section  203  (l)1  of  the  Act  of  September 
8,  1916,  and  losses  other  than  those  specifically  enumer- 
ated are  not  deductible." 

Prior  to  September  10,  1917,  the  Treasury  Depart- 
ment (T.  D.  2395)  held  that  amounts  paid  to  States  on 
account  of  inheritance,  succession  or  legacy  taxes  were 
a  lawful  deduction,  but  T.  D.  2524  revoked  this  ruling, 
so  that  State  inheritance  taxes  are  not  now  deductible. 
This  ruling  also  applies  to  non-resident  decedents'  es- 
tates. The  Federal  estate  tax  is  not  determined,  does 
not  attach  and  cannot  be  assessed  or  paid  until  the  net 
estate  upon  which  it  is  based  has  been  exactly  estab- 
lished. The  estate  tax,  therefore,  cannot  be  deducted 
from  the  gross  estate  to  determine  the  taxable  net 
estate. 

Non-resident  decedent. — The  term  "non-resident  de- 
cedent" includes  aliens  and  citizens  of  the  United  States 
residing  outside  of  the  United  States  at  the  time  of 
their  death.  For  example,  the  estate  of  a  citizen  of 
the  United  States  who  had  prior  to  his  death  main- 
tained his  principal  residence  in  London,  would  be 
taxed  as  that  of  a  non-resident.  Residents  of  the  Phil- 
ippine Islands  and  Porto  Rico  are  taxed  as  non-resi- 
dents upon  any  property  in  the  United  States. 

i  Such  losses  are  those  arising  from  fires,  storms,  shipwrecks  or  other 
casualty,  and  theft,  when  not  compensated  for,  by  insurance  or  otherwise. 


394  INCOME    AND    FEDERAL    TAX    REPORTS 

Notice. — (Also  termed  "Thirty-day  Notice,"  Forms 
704,  705  and  714.)  "Notice"  means  the  written  notice 
required  to  be  filed  with  the  collector  within  thirty  days 
after  letters  testamentary  or  of  administration  are 
granted,  or  within  thirty  days  after  coming  into  pos- 
session of  property  of  the  decedent,  except  where  pos- 
session of  the  property  was  obtained  prior  to  decedent's 
death,  in  which  case  the  notice  must  be  filed  within 
thirty  days  after  decedent's  death.  Executors  and  ad- 
ministrators are  required  to  file  Form  704;  transfer 
agents  and  registrars,  Form  714,  and  all  others  must 
file  Form  705. 

Person.  —  "Person"  includes  partnerships,  corpora- 
tions and  associations. 

Resident  decedent. — This  term  includes  citizens  and 
aliens  residing  at  the  time  of  their  death  in  the  United 
States. 

Return. — "Eeturn"  (Form  706)  means  the  statement  re- 
quired to  be  executed  by  the  executors  and  filed  with 
the  collector  within  one  year  after  the  decedent's  death, 
setting  forth  in  detail  the  amount  of  the  gross  estate, 
the  deductions  allowed,  the  amount  of  the  net  estate  and 
the  tax  payable  thereon.  This  return  is  required  in 
the  case  of  resident  decedents  where  the  gross  estate 
exceeds  $60,000,  or  where  the  net  estate  exceeds  the 
specific  exemption  of  $50,000.  A  return  is  required  for 
every  non-resident  decedent's  estate  regardless  of  the 
size  of  the  estate. 

United  States. — The  term  "United  States"  includes  all 
the  States,  the  territories  of  Alaska  and  Hawaii,  and 
the  District  of  Columbia.  It  does  not  include  the  Phil- 
ippine Islands,  the  Virgin  Islands  or  Porto  Rico. 

DUTIES  OF  EXECUTORS  AND  ADMINISTRATORS 

Thirty-day  Notice — Form  704. — Every  executor  or  ad- 
ministrator, within  thirty  days  after  qualifying  as  such, 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  395 

or  after  coming  into  possession  of  any  property  of  the 
decedent,  whichever  event  first  occurs,  shall  give  writ- 
ten notice  thereof  on  Form  704  to  the  collector  of  in- 
ternal revenue  in  whose  district  was  decedent's  domicile 
at  the  time  of  death;  and  in  the  case  of  a  non-resident, 
with  the  collector  of  the  district  in  which  the  property 
is  located.  If  the  non-resident's  property  is  located  in 
more  than  one  district,  the  notice  must  be  filed  with 
the  collector  at  Baltimore,  Md. 

However,  if  the  decedent  was  a  resident  of  the 
United  States,  and  the  gross  estate  does  not  exceed 
$60,000  or  the  net  estate  does  not  exceed  $50,000,  then 
such  notice  is  not  required  to  be  filed.1  (See  back  of 
Form  704.)  But,  where  the  gross  estate  exceeds  $60,- 
000,  even  though  the  net  estate  may  be  less  than 
$50,000,  such  notice  must  be  filed.2     (Beg.— Art.  32.) 

Ancillary  executors  or  administrators  of  non-resident 
decedents'  estates  are  required  to  file  Form  704  within 
the  time  specified  above,  regardless  of  the  size  of  the 
decedent's  estate.  The  estate  of  a  non-resident  decedent 
is  liable  for  the  tax  upon  that  portion  of  the  estate 
physically  situated  within  the  United  States,  and,  in 
addition,  upon  the  value  of  the  stock  of  domestic  cor- 
porations owned  by  the  decedent  at  the  time  of  his 
death,  whether  or  not  such  stock  be  physically  located 
in  the  United  States.  Bonds  of  domestic  corporations 
owned  by  non-resident  decedents  and  physically  located 
outside  of  the  United  States  are  not  deemed  "property 
within  the  United  States." 

The  filing  of  the  notice  should  not  be  delayed  in  order 
to  secure  exact  information  concerning  the  value  of  the 
gross  or  net  estate.    Approximate  figures  may  be  given. 

i  For  example,  if  the  gross  estate  amounts  to  $58,000,  and  the  net  estate 
to  $48,000,  the  notice  will  not  be  required.  But,  even  though  the  gross 
estate  is  only  $58,000,  if  the  net  estate  is  over  $50,000  (that  is,  in  excess 
of  the  specific  exemption),  the  notice  must  be  filed. 

2  Thus,  if  the  gross  estate  is  $65,000  and  the  net  estate  $45,000,  the 
notice  must  be  filed. 


396  INCOME   AND    FEDERAL    TAX    REPORTS 

Return— Form  706. — It  is  the  duty  of  every  executor 
or  administrator  to  file,  within  one  year  after  the  de- 
cedent's death,  a  return  on  Form  706,  where  the  gross 
estate  of  a  resident  decedent  exceeds  $60,000  or  the  net 
estate  exceeds  $50,000.  If,  at  the  expiration  of  the 
year,  it  is  impossible  for  the  executor  to  show  upon 
the  return  complete  and  accurate  data  of  the  gross  es- 
tate and  deductions,  he  should  file  a  tentative  return, 
and  inform  the  collector  of  the  cause  for  delay.  The 
collector  will,  in  his  discretion,  extend  the  time  for 
filing  the  final  return. 

A  return  is  required  of  the  estate  of  every  non-resi- 
dent owning  property  physically  located  within  the 
United  States,  or  owning  stocks  of  domestic  corpora- 
tions regardless  of  their  physical  situs. 

Payment  of  tax. — The  tax  is  due  and  payable  one  year 
after  the  decedent's  death,  and  should  be  paid  by  the 
executor  or  administrator.  A  discount  at  the  rate  of 
5  per  cent  per  annum  is  allowed  for  prior  payment.  If 
the  tax  is  not  paid  within  90  days  after  it  is  due  inter- 
est is  added  at  the  rate  of  10  per  cent  or  6  per  cent 
per  annum,  as  the  case  may  be,  calculated  from  the  day 
of  decedent's  death  to  the  date  of  payment,  and  the  tax 
becomes  a  lien  on  the  gross  estate  for  ten  years.  (See 
Payment  of  Tax;  Penalties.) 

It  is  important  for  the  executor  to  keep  in  mind  that 
Section  208  of  the  law  expressly  provides  that,  so  far 
as  it  is  practicable  and  unless  otherwise  directed  by  the 
will  of  the  decedent,  the  tax  must  be  paid  out  of  the 
estate  before  its  distribution.  This  brings  up  the  ques- 
tion in  a  testate's  estate  whether  the  tax  shall  be  shared 
proportionately  by  all  the  legatees,  or  borne  entirely  by 
the  residuary  legatee.  Where  the  testator  expressly  di- 
rects that  all  inheritance  taxes  be  paid  out  of  the  resid- 
uary estate,  the  will,  of  course,  governs.  But,  where 
the  will  is  silent,  whether  or  not  the  tax  is  to  be  borne 
by  the  residuary  legatee  depends  upon  the  laws  of  the 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  397 

State  where  the  estate  is  administered.  If  the  laws  of 
the  State  make  no  provision  for  the  apportionment  of 
the  tax,  the  executor  should  petition  the  surrogate,  or 
the  judge  of  the  probate  court,  for  an  order  expressly 
directing  the  apportionment  of  the  tax,  rather  than  as- 
sume that  it  should  be  borne  by  the  residuary  estate. 
In  the  case  of  an  estate  of  a  decedent  who  died  without 
making  a  will,  this  question  will  not  be  encountered; 
the  residuary  estate,  after  being  charged  with  the 
amount  of  the  tax,  will  be  distributed  among  the  heirs 
and  next  of  kin  according  to  law. 


DUTIES  OF  BENEFICIARIES,  HEIRS,  DONEES,  TRUSTEES  AND 
FIDUCIARIES 

Where  the  estate  of  a  decedent  is  represented  by  a 
duly  appointed  executor  or  administrator,  no  obligation 
to  file  the  thirty-day  notice  (Form  705),  or  the  return 
(Form  706)  or  to  pay  the  tax  is  imposed  upon  a  bene- 
ficiary,1 heir,  donee,  trustee  or  fiduciary.  It  is  only  in 
cases  where  a  taxable  estate  has  no  duly  appointed  rep- 
resentative, or  where  property  of  the  decedent  passes 
directly  to  the  beneficiary  without  coming  under  the 
control  of  the  executor,  that  the  beneficiary,  or  his 
guardian,  trustee  or  fiduciary  must  file  the  notice  and 
return  and  pay  the  tax.  In  this  respect  the  Solicitor  of 
Internal  Revenue  has  given  his  opinion,  as  follows : 

"The  said  law  defines  the  term  'executor'  as  mean- 
ing 'the  executor  or  administrator  of  the  decedent,  or, 
if  there  is  no  executor  or  administrator,  any  person  who 
takes  possession  of  any  property  of  the  decedent,' "  and 
further  states: 

"Manifestly  the  purpose  of  the  law  is  to  secure  such 
information  and  returns  as  will  enable  the  Government 

i  Wherever  the  term  "beneficiary"  is  used  in  this  chapter,  it  includes 
heirs,  donees,  trustees,  fiduciaries,  and  all  other  persons  holding  property 
of  a  decedent. 


398  INCOME   AND    FEDERAL    TAX    REPORTS 

to  properly  execute  the  law  and  collect  such  taxes  as 
may  be  thereby  imposed. 

"In  view  of  this  uniform  interpretation  as  to  the  re- 
quirement of  notice  and  returns  in  all  matters  of  rev- 
enue taxation,  as  well  as  the  specific  language  of  the 
law,  I  am  of  the  opinion  that  you  are  justified  in  the 
preparation  of  regulations  requiring  persons  who  come 
into  the  possession  of  the  property  of  a  decedent,  or 
any  part  thereof,  prior  to  the  appointment  of  executors 
or  administrators,  to  give  due  and  proper  notice  to  the 
Collector  of  that  fact.  When  executors  or  administra- 
tors are  appointed  they,  of  course,  supersede  all  other 
persons  in  the  control  of  the  property,  whether  such 
persons  are  in  possession  or  not,  and  the  duty  of  giving 
notice  and  making  returns  for  the  entire  estate  imme- 
diately devolves  upon  such  executors  or  administrators." 

It  is  the  intention  of  the  Treasury  Department  to 
give  a  broad  construction  to  the  expression  "any  per- 
son who  takes  possession  of  any  property  of  the  de- 
cedent" contained  in  Section  200,  and  to  impose  upon 
such  persons  the  duties  and  obligations  of  executors, 
where  none  has  been  duly  appointed. 

The  law  contemplates  also  that  the  notice  should  be 
filed  by  all  persons  who  shall  have  received,  within  two 
years  prior  to  the  death  of  the  decedent,  any  material 
part  of  decedent's  property  either  as  a  gift  in  contem- 
plation of  death,  or  by  a  transfer  intended  to  take  legal 
effect  at  or  after  decedent's  death,  or  by  a  so-called  sale 
which  was  not  a  bona  fide  sale  for  a  fair  consideration 
in  money  or  money's  worth.  With  the  notice  to  the  col- 
lector, the  donee  or  transferee  may  file  such  evidence  as 
may  be  desired  to  establish  whether  the  gift  or  trans- 
fer was  in  contemplation  of,  or  intended  to  take  effect 
at,  the  donor's  or  transferror's  death,  or  whether  the 
sale  was  bona  fide. 

Thirty-day  Notice — Form  705. — Where  the  estate  is  not 
represented  by  a  duly  appointed  executor  or  adminis- 


FEDERAL   INHERITANCE    OR    ESTATE    TAX  399 

trator,  Form  705  must  be  filed  within  30  days  after  the 
death  of  the  decedent,  or  within  30  days  after  coming 
into  possession  of  property  of  decedent,  by  the  follow- 
ing persons: 

A.  In  the  case  of  estates  of  resident  decedents. — 
(1)  By  the  surviving  husband  or  wife,  as  the  case  may 
be,  for  one-half  the  value  at  the  decedent's  death,  of  com- 
munity property  owned  by  the  decedent  and  the  sur- 
vivor. 

(2)  By  the  first  taker  after  the  decedent  of  any  of 
decedent's  real  property  where  this  passes,  in  accord- 
ance with  local  law,  directly  to  the  heirs  of  the  decedent. 

(3)  By  donees  who  have  received  within  two  years 
prior  to  the  decedent's  death  any  gift  of  material  value 
from  the  decedent,  or  who  have  received  at  any  time 
whatever  gifts  made  by  decedent  in  contemplation  of, 
or  intended  to  take  legal  effect  at,  death. 

(4)  By  trustees  holding  property  conveyed  during 
his  lifetime  by  the  decedent  in  contemplation  of  death 
(or  with  the  intent  to  provide  for  others  than  the  de- 
cedent at  or  after  decedent's  death),  regardless  of  the 
date  of  the  instrument  making  the  conveyance,  or  the 
date  of  possession  by  the  trustee,  or  the  date  of  vesting 
of  the  right  of  survivors  to  possession  or  enjoyment  at 
or  after  decedent's  death. 

(5)  By  fiduciaries  holding  property  of  any  kind 
jointly  or  in  entirety  for  the  decedent  and  another  or 
others. 

(6)  By  any  other  person  holding  or  taking  any  prop- 
erty upon  decedent's  death  which  will  not  pass  through 
the  executor  or  administrator. 

The  notice  should  be  filed  with  the  collector  for  the 
district  in  which  the  decedent  maintained  his  principal 
residence. 

B.  Estates  of  non-resident  decedents. — All  persons 
who  at  any  time  have  received  property  from  a  non- 


400  INCOME   AND    FEDERAL    TAX    REPORTS 

resident  decedent  as  a  gift  in  contemplation  of  death, 
and  all  persons,  including  beneficiaries,  heirs,  trustees 
and  fiduciaries,  who  hold  any  property  of  a  non-resi- 
dent decedent  physically  located  within  the  United 
States,  shall  file  the  notice  (Form  705)  with  the  col- 
lector, regardless  of  the  amount  of  the  property.  The 
notice  must  be  filed  within  30  days  from  the  decedent's 
death  with  the  collector  of  the  district  in  which  the 
property  is  located.  If  the  property  is  located  in  more 
than  one  district,  the  notice  must  be  filed  with  the  col- 
lector at  Baltimore,  Md.  If  information  of  a  non-resi- 
dent decedent's  death  is  not  received  in  time  to  enable 
the  beneficiary  to  file  the  notice  within  the  thirty-day 
period,  no  penalty  for  failure  to  file  such  notice  will  be 
imposed  if  the  notice  is  filed  within  30  days  from  the 
time  information  of  decedent's  death  was  received. 
Return — Form  706. — Keturns  must  be  made  as  follows: 

A.  Resident  decedent's  estate. — In  the  case  of  estates 
having  no  executors  or  administrators,  or  where  any 
part  of  the  gross  estate  passes  direct  to  a  beneficiary, 
the  law  places  upon  the  separate  beneficiaries  the  pre- 
cise duties  with  regard  to  filing  of  the  return  and  pay- 
ment of  the  tax  that  are  otherwise  imposed  on  execu- 
tors. Where  the  property  is  held  for  the  beneficiary  by 
guardians,  trustees,  or  fiduciaries,  the  return  may  be 
filed  by  such  representatives. 

Each  beneficiary  making  return  for  any  part  of  the 
estate  is  required  to  give  full  information  regarding  the 
estate,  and  the  collector  will  compile  a  final  and  com- 
plete return  from  the  several  returns,  if  any,  made  by 
the  beneficiaries  and  assess  the  tax  accordingly. 

B.  Non-resident  decedent's  estate. — If  the  foreign 
executor  has  failed  to  file  the  return  within  one  year 
from  the  date  of  decedent's  death,  the  collector  shall  re- 
quire the  return  to  be  made  by  a  beneficiary.  No  de- 
ductions whatever  may  be  taken  upon  such  returns 
unless  it  is  proved  that  all  the  non-resident's  property 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  401 

is  located  within  the  United  States  and  is  included  in 
the  gross  estate  on  the  return. 

Under  no  circumstances  may  a  beneficiary  release  to 
a  foreign  executor  or  administrator  or  foreign  bene- 
ficiary of  a  non-resident  decedent's  estate  any  of  de- 
cedent's property,  until 

(1)  The  amount  of  tax  has  been  paid;  or 

(2)  Ancillary  letters  have  been  taken  out  in  the 
United  States;  or 

(3)  Provision  has  been  made  by  the  estate  for  the 
satisfaction  of  the  tax  lien  resting  upon  decedent's 
property  in  this  country. 

When  ancillary  letters  have  been  taken  out,  or  pro- 
vision made  for  the  payment  of  the  tax,  the  beneficiary 
should  immediately  notify  the  collector  of  such  fact.  A 
penalty  will  be  imposed  for  failure  to  comply  with  these 
requirements. 

Payment  of  tax. — Payment  of  the  tax  by  the  bene- 
ficiary is  required  only  where  he  has  filed  a  return,  or 
released  property  of  a  non-resident  decedent's  estate  to 
a  foreign  executor,  administrator  or  beneficiary  and 
withheld  the  amount  of  tax  due. 

It  is  very  important  for  trustees  to  note  that  they  are 
personally  liable  for  the  amount  of  any  tax  due  and 
unpaid  upon  the  value  of  decedent's  interest  in  any 
property  in  their  hands  which  had  been  transferred  to 
them  in  trust  at  any  time  by  the  decedent,  if  such  trans- 
fer was  made  by  the  decedent  in  contemplation  of  death. 
Such  property,  to  the  extent  of  decedent's  interest 
therein,  is  subject  to  a  lien  for  the  amount  of  the  tax. 

DUTIES  OF  BANKING  INSTITUTIONS  AND  SAFE  DEPOSIT 
COMPANIES 

Thirty-day  notice— Form  705. — The  thirty-day  notice 
provisions  apply  as  follows  to  the  two  classes  of  es- 
tates : 


402  INCOME   AND    FEDERAL    TAX    REPORTS 

A.  Resident  decedent's  estate. — Where  the  property 
of  a  resident  decedent's  estate  is  taken  in  charge  by  a 
duly  appointed  executor  or  administrator  there  is  no 
obligation  upon  a  bank  or  safe  deposit  company  to  file 
the  notice  or  to  see  that  the  executor  files  the  notice, 
and  the  bank  or  safe  deposit  company  may  safely  re- 
lease all  funds  and  other  property  unto  the  executor  or 
administrator.  But,  if  the  property  held  by  the  bank  or 
safe  deposit  company  is  a  joint  account,  or  any  other 
property  which  would  not  pass  through  the  executor's 
hands,  the  primary  duty  of  filing  the  notice  is  upon 
the  bank  or  safe  deposit  company.  If  the  bank  or  safe 
deposit  company,  however,  depends  upon  the  executor 
to  file  the  notice  for  property,  which  does  not  come  into 
his  charge,  it  does  so  at  its  own  risk.  Unless  the  bank 
or  safe  deposit  company  is  satisfied  that  the  gross  es- 
tate of  the  decedent  is  less  than  $60,000  or  the  net  es- 
tate is  less  than  $50,000,  it  should  file  the  notice  for  its 
own  protection  and  thus  relieve  itself  from  all  liability. 

B.  Non-resident  decedent's  estates. — Where  ancillary 
letters  are  taken  out  in  the  United  States,  and  the  prop- 
erty of  a  non-resident  decedent  in  the  possession  of  a 
bank  or  safe  deposit  company  is  taken  in  charge  by  the 
ancillary  executor  or  administrator,  there  is  no  obliga- 
tion upon  a  bank  or  safe  deposit  company  to  file  the 
notice,  and  the  property  may  safely  be  released  to  the 
ancillary  representative.  But  if  no  such  representative 
has  qualified  within  thirty  days  after  the  death  of  a 
non-resident  decedent  or  notice  thereof,  then  the  bank 
or  safe  deposit  company  should  promptly  file  the  notice 
(Form  705)  with  the  collector,  regardless  of  the  amount 
of  the  property  held,  and  retain  such  property  in  its 
custody. 

Return — Form  706. — No  return  is  required  from  a  bank 
or  safe  deposit  company  where  the  property  of  the 
decedent  has  been  delivered  to  a  duly  appointed  execu- 
tor  or   administrator,   or  where   ancillary  letters   are 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  403 

taken  out  in  the  United  States,  to  an  ancillary  execu- 
tor or  administrator. 

Where  a  bank  or  safe  deposit  company  holds  prop- 
erty of  a  resident  decedent  in  a  joint  account,  the  col- 
lector will  look  either  to  the  executor  or  to  the  succeed- 
ing owner,  depending  upon  the  circumstances  in  the 
particular  case,  for  making  the  return. 

In  the  case  of  a  non-resident  decedent,  if  the  foreign 
executor  has  failed  to  file  the  return  within  one  year 
from  the  date  of  decedent's  death,  the  collector  shall  re- 
quire return  to  be  made  by  the  bank  or  safe  deposit 
company.  No  deductions  whatever  may  be  taken  upon 
such  return  unless  there  is  a  showing  that  all  the  non- 
resident's property  is  located  in  the  United  States,  and 
is  included  in  the  gross  estate  on  the  return. 

Under  no  circumstances  may  a  bank  or  safe  deposit 
company  release  to  a  foreign  executor  or  administrator 
or  to  a  foreign  beneficiary  of  the  non-resident  decedent 
any  property  within  the  United  States  at  the  time  of 
decedent's  death  until  either 

(1)  The  tax  due  has  been  paid;  or 

(2)  Ancillary  letters  have  been  taken  out  in  the 
United  States;  or 

(3)  Provision  has  been  made  for  the  satisfaction  of 
the  tax  lien  resting  upon  decedent's  property  in  the 
United  States. 

When  ancillary  letters  have  been  granted,  or  pro- 
vision made  for  the  payment  of  the  tax,  full  and  com- 
plete notice  thereof  shall  immediately  be  given  to  the 
collector.  A  penalty  will  be  imposed  for  failure  to  com- 
ply with  these  requirements. 

Payment  of  tax. — Payment  of  the  tax  by  a  bank  or 
safe  deposit  company  is  only  required  where  it  has  filed 
a  return,  or  where  it  has  released  property  of  a  non- 
resident decedent's  estate  to  a  foreign  executor,  admin- 
istrator or  beneficiary  and  withheld  the  amount  of  the 
tax  due. 


404  INCOME   AND    FEDERAL    TAX    REPORTS 

DUTIES  OF  AGENTS  OR  REPRESENTATIVES  OF  NON-RESIDENT 

DECEDENTS 

Conditions  of  release  to  foreign  administrator. — Under 
no  circumstances  may  the  local  agent,  representative, 
etc.,  release  to  a  foreign  administrator  or  executor  or  a 
foreign  beneficiary  of  the  decedent  any  property  within 
the  United  States  at  the  time  of  the  decedent's  death 
until  either  (1)  the  tax  due  has  been  paid,  or  (2)  ancil- 
lary letters  have  been  taken  out  in  the  United  States, 
or  (3)  the  retaining  by  the  local  representative  of  a 
sum  sufficient  to  guarantee  the  payment  of  the  entire 
tax  that  would  be  due.  When  ancillary  letters  have 
been  taken  out,  or  provision  made  for  the  payment  of 
the  tax,  the  local  agent  shall  immediately  inform  the 
collector  fully  as  to  the  facts  (T.  D.  2454). 

The  duties  of  agents  or  representatives  of  non-resi- 
dent decedent's  estates,  with  regard  to  the  filing  of  the 
notice  and  the  return,  and  the  payment  of  the  tax,  are 
the  same  as  those  of  banking  institutions  and  safe  de- 
posit companies  with  respect  to  the  estate  of  non-resi- 
dent decedents.  These  duties  are  described  in  pages 
401-403  of  this  chapter. 

With  relation  to  non-resident  decedents,  the  thirty- 
day  notice  (Eeturn  Form  706)  and  tax  payment  are 
required  of  representatives  in  this  country  where  no 
executor  acts  within  the  required  time.  An  inquiry 
was  made  as  to  the  liability,  under  Section  205,  of  rep- 
resentatives in  this  country  of  a  non-resident  decedent 
leaving  property  in  the  hands  of  representatives,  and 
where,  so  far  as  the  representatives  knew,  no  execu- 
tor had  been  appointed.  Section  205  requires  that  the 
executor,  within  thirty  days  after  qualifying  as  such,  or 
after  taking  possession  of  any  property  of  a  decedent, 
whichever  event  first  occurs,  shall  give  notice  to  the 
Collector  of  Internal  Revenue,  and  that  later  the  ex- 
ecutor shall  file  return  of  the  estate.     Section  207  re- 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  405 

quires  that  the  executor  shall  pay  the  tax  to  the  collec- 
tor or  his  deputy.  In  Section  200  the  term  "executor" 
is  denned  as  meaning  either  the  executor  or  adminis- 
trator, or  if  there  is  none,  any  person  who  takes  pos- 
session of  any  property  of  the  deceased. 

In  this  certain  case  it  was  argued  that  the  represen- 
tatives in  this  country  of  the  non-resident  decedent  do 
not  "take  possession"  of  decedent's  property,  and  that, 
since  the  representatives  are  neither  administrators 
nor  beneficiaries,  they  cannot  be  required  to  file  the 
thirty-day  notice,  or  return,  or  make  payment  of  the 
tax. 

From  that  view  the  Treasury  Department  dissented, 
for  although  there  is  no  change  of  agent  or  representa- 
tive, there  was  immediately  upon  the  non-resident's 
death  a  complete  change  in  the  character  of  the  agency. 
Prior  to  the  death,  the  local  representatives  held  the 
property  in  charge  for  the  non-resident,  but  imme- 
diately the  death  occurred  they  held  it  subject  to  the 
order  of  executors  or  administrators,  and  for  the  bene- 
ficiaries legally  entitled  thereto.  At  the  moment  of 
death  there  was,  on  the  part  of  the  local  representa- 
tives, an  actual  legal  taking  of  possession  for  succeed- 
ing owners,  a  change  in  the  conditions  of  possession  so 
complete  that  no  actuality  would  be  added  by  the  sub- 
stitution of  other  agents. 

It  is  clear,  therefore,  that  such  representatives  are 
responsible  for  the  filing  of  the  thirty-day  notice,  and 
can  be  saved  from  that  responsibility  only  if,  prior  to 
the  expiration  of  thirty  days  from  the  death  of  the  non- 
resident, the  required  notice  (Form  704)  has  been  filed 
by  the  executors  or  administrators. 

Further  weight  is  given  to  this  contention  by  a  con- 
sideration of  the  evident  intent  of  Congress  in  its 
definition  of  the  term  "executor"  (see  Section  200  of 
Law).  This  definition  was  given  with  the  sole  purpose 
of  providing  effective  means  for  the  ascertainment  and 


406  INCOME   AND    FEDERAL    TAX    REPORTS 

collection  of  the  tax  due  in  every  case  where  the  com- 
plete facts  might  not  be  known  to  the  executor  or  where 
the  executor  might  be  in  a  position  successfully  to  evade 
his  responsibilities  under  the  Act. 

The  object  on  the  part  of  Congress  in  causing  "any 
person  who  takes  possession  of  any  property  of  the  de- 
cedent" to  share  equally  with  executors  and  adminis- 
trators the  liability  to  render  notice  and  return  and  to 
pay  the  tax,  was  that  there  should  not  be,  under  any 
circumstances  of  transmission,  a  failure  of  the  admin- 
istrative power  to  secure  a  full  disclosure  of  the  facts 
and  a  complete  satisfaction  of  the  tax.  Congress  must 
have  foreseen,  in  enacting  the  final  paragraph  of  Sec- 
tion 202,1  that  without  such  an  administrative  require- 
ment as  this  the  tax  due,  because  of  stock  owned  by  a 
non-resident  in  domestic  corporations,  could  be  success- 
fully evaded. 

The  definition  of  "executor"  in  Section  200  was  made 
intentionally  so  broad  that  no  property  subject  to  the 
tax  could  escape  taxation  through  any  uncertainty  as 
to  the  person  liable  for  giving  accurate  information 
with  regard  thereto.  In  the  case  of  a  non-resident  de- 
cedent, the  appointment  of  a  foreign  executor  or  ad- 
ministrator will  not  relieve  a  person  in  control  of 
property  in  the  United  States  from  these  duties,  unless 
and  until  he  has  made  return  and  tendered  payment  of 
tax. 

DUTIES  OF  CORPORATIONS  AND  THEIR  TRANSFER  AGENTS, 
REGISTERS  OF  BONDS  AND  PAYING  AGENTS 

Duties  of  corporate  agents  denned. — The  following  is  an 
extract  from  Treasury  Decision  2490,  defining  the  du- 
ties of  corporate  transfer  agents,  registers  of  bonds  and 
paying  agents,  and  of  corporations  performing  these 
duties  themselves: 

"(1)  Where  the  transfer  of  stock  or  bonds  or  payment  of  dividends  or 
interest  theretofore  the  legal   property  of  a  decedent,  whether  a  resident 

i  Section  202,  subdivision  (c). 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  407 

or  a  non-resident,  is  made  to  or  upon  the  order  of  an  executor  or  administra- 
tor acting  under  letters  granted  in  the  United  States,  Hawaii,  or  Alaska, 
the  corporate  agent  or  officer  will  not  be  required  to  file  the  thirty-day 
notice,  make  return,  or  pay  tax. 

"(2)  The  thirty-day  notice  (Form  714)  is  required  to  be  filed  whenever 
a  corporation,  its  transfer  agent,  register,  or  paying  agent  is  called  upon 
to  make  a  transfer  of  stocks  or  bonds,  or  to  pay  interest  or  dividends  to 
any  person  succeeding  in  right  thereto  [of]  a  stockholder  or  bondholder 
who,  since  September  8,  1916,  has  died  domiciled  outside  the  United  States, 
Hawaii,  or  Alaska,  unless  such  successor  in  interest  is  an  executor  or  ad- 
ministrator of  the  non-resident  decedent  acting  under  letters  granted  within 
the  United  States,  Hawaii,  or  Alaska. 

"(3)  This  notice  (Form  714)  must  be  filed  for  dividends  declared  prior 
to  the  day  of  death  and  for  interest  payable  after  death  to  the  extent  of 
the  portion  accrued  to  the  day  of  death. 

"(4)  If  this  notice  (Form  714)  be  filed  as  required  either  within  thirty 
days  from  death  or  immediately  upon  receipt  of  the  order  for  transfer  or 
payment,  the  transfer  or  payment  need  not  be  postponed.  The  collector, 
immediately  upon  receipt  of  the  notice,  will  communicate  with  the  foreign 
executor  or  succeeding  party  in  interest,  advising  [him]  of  the  require- 
ments of  the  estate  taxing  act  and  furnishing  blank  Forms  706  for  the 
making  of  the  return.  If,  within  the  legal  period,  the  tax  is  not  paid, 
proceedings  will  be  instituted  under  Section  208  of  the  taxing  act  for  the 
sale  of  property  and  the  satisfaction  of  the  tax. 

"(5)  This  regulation  is  promulgated  in  view  of  present  international 
conditions,  and  is  subject  to  revocation  should  it  be  demonstrated  that 
the  accommodation  herein  made  to  corporations  and  their  agents  result  in 
insecurity  of  the  revenue.*  This  regulation  is  not  to  be  construed  in  any 
degree  as  modifying  the  interpretation  hitherto  given  by  the  department 
of  the  term  "executor"  as  used  in  Section  200  of  the  act  of  September 
8,  1916."2 

It  should  be  noted  that  where  the  notice  on  Form  714 
has  been  filed  and  stock  formerly  owned  by  a  non-resi- 
dent decedent  has  been  transferred,  that  the  lien  for 
the  tax  can  be  enforced  under  provisions  of  Section  208 
of  the  law  whenever  necessary  to  protect  the  Govern- 

i  That  is  to  say,  the  Treasury  Department  reserves  the  right  to  hold  up 
the  transfer  until  either  (1)  the  tax  due  has  been  paid,  or  (2)  ancillary 
letters  have  been  taken  out  in  the  United  States,  or  (3)  provision  has 
been  made  for  the  satisfaction  of  the  tax  lien  resting  upon  the  non-resident 
decedent's  property  in  the  United  States. 

2  In  other  words,  the  Treasury  Department  reserves  the  right,  where 
necessary,  to  impose  the  duties  and  obligations  of  executors  upon  cor- 
porations and  their  transfer  agents,  registrars  and  paying  agents,  of  filing 
the  return  and  paying  the  tax. 


408  INCOME   AND    FEDERAL    TAX    REPORTS 

ment,  regardless  of  the  possession  of  the  stock  by  suc- 
ceeding owners.  Purchasers  who  acquire  stock  for- 
merly registered  in  the  name  of  a  non-resident  decedent 
may  therefore  find  a  lien  for  the  amount  of  tax  attached 
to  their  property  if  the  stock  was  purchased  from  a 
person  other  than  an  ancillary  executor  or  administra- 
tor. The  purchaser  may  protect  himself  by  insisting 
that  the  sellor  first  deposit  with  the  collector  such  a 
sum  as  will  fully  satisfy  the  amount  of  tax,  and,  upon 
presentation  of  the  collector's  receipt,  he  may  safely 
pay  the  purchase  price  of  the  stock. 

RETURNS 

General  rules. — Under  the  various  sections  of  this 
chapter  defining  the  duties  of  representatives  of  a  de- 
cedent's estate  it  has  been  stated  under  what  conditions 
a  return  (Form  706)  is  required.  In  this  section  will 
be  given  the  general  rules,  regulations  and  instructions 
regarding  the  contents  of  the  return  and  the  manner  of 
filing. 

Section  205  of  the  law  provides  that  an  executor  shall 
file  a  return  under  oath,  in  duplicate,  at  such  times  and 
in  such  manner  as  may  be  required  by  the  Commis- 
sioner of  Internal  Eevenue.  As  the  tax  is  due  and  pay- 
able one  year  after  the  decedent's  death,  the  Treasury 
Department  requires  the  return  to  be  filed  on  or  before 
that  date. 

A  return  is  required  of  the  estate  of  every  resident 
decedent  whose  gross  estate  exceeds  in  value  $60,000, 
or  whose  net  estate  has  any  value  in  excess  of  the 
specific  exemption  of  $50,000.1 

A  return  is  required  of  the  estate  of  every  non- 
resident decedent  owning  property  in  the  United 
States,  including  stocks  of  domestic  corporations,  even 
though  the  certificates  were  physically  located  outside 

i  For  example:  Gross  estate  $58,000,  deductions  $4,000,  specific  exemp- 
tion $50,000,  net  estate  $4,000.     In  this  estate  a  return  should  be  filed. 


FEDERAL   INHERITANCE    OR    ESTATE    TAX  409 

of  the  United  States  at  the  time  of  decedent's  death. 
A  return  is  also  required  if  the  decedent  has  at  any- 
time transferred  any  property  in  contemplation  of 
death.1 

Tentative  and  final  returns. — The  logical  time  for  filing 
the  return  is  coincident  with  the  final  settlement  of  the 
estate  (where  this  occurs  before  the  expiration  of  one 
year  from  decedent's  death),  as  at  that  time  the  values 
of  the  gross  estate  and  items  of  deductions  may  be  ac- 
curately determined.  Where  the  administration  of  the 
estate  is  unduly  delayed  and  it  is  desired  to  take  ad- 
vantage of  the  discount  allowed  for  prior  payment  of 
the  tax,  a  tentative  return  will  be  accepted,  provided 
reasonably  accurate  information  is  given  of  the  gross 
estate,  and  of  all  items  of  deductions  that  have  been 
actually  determined  (i.  e.,  exclusive  of  estimated  items). 
Where  a  tentative  return  has  been  filed  within  the  year, 
a  final  return  must,  nevertheless,  be  made  at  the  expi- 
ration of  the  year.  If,  at  the  expiration  of  the  year,  it 
is  impossible  to  make  the  final  return,  the  collector  may, 
upon  application,  grant  an  extension  not  exceeding 
ninety  days.  If,  at  the  expiration  of  ninety  days,  the 
cause  for  delay  still  exists  and  is  unavoidable,  the  col- 
lector may  extend  the  time  for  filing  until  the  reason- 
able ground  for  delay  has  been  removed.  (T.  D. 
2637.) 

Distribution  or  sale  of  personal  effects. — As  the  Treas- 
ury Department  desires  to  verify  the  accuracy  of  all 
returns,  executors  or  other  representatives  of  estates 
liable  to  tax  are  directed  not  to  sell,  dispose  or  dis- 
tribute any  article  of  furniture,  jewelry,  works  of  art 

i  Thus,  if  a  non-resident  decedent  had  assigned  property  to  a  resi- 
dent trustee,  under  a  trust  agreement,  providing  for  the  payment  of  the 
income  thereon  to  him  (the  decedent)  for  life,  and  after  his  death,  the 
property  to  revert  to  his  estate,  or  be  otherwise  disposed  of,  a  return  should 
be  made  by  the  executor  or  representative  of  the  decedent's  estate.  If 
the  return  is  not  made  this  duty  devolves  upon  the  resident  trustee,  who 
must  also  pay  the  tax. 


410  INCOME   AND    FEDERAL    TAX    REPORTS 

and  other  personal  effects  until  the  value  thereof  has 
been  verified  by  a  government  agent.  Arrangement 
may  be  made  with  the  collector  to  have  this  done 
promptly. 

Where  to  file. — If  the  decedent  maintained  more  than 
one  residence,  his  principal  residence  (actual  domicile) 
determines  the  internal  revenue  district  in  which  the 
return  must  be  filed  and  tax  paid. 

If  decedent  was  a  non-resident  and  his  sole  property 
within  the  United  States,  Hawaii  or  Alaska  was  stocks 
or  bonds  of  an  American  corporation,  his  return  should 
be  filed  with  the  collector  in  whose  district  the  head 
office  of  the  corporation  is  located,  unless  the  estate  has 
a  representative  in  the  United  States  having  the  stocks 
or  bonds  in  charge,  in  which  case  the  return  may  be 
filed  with  the  collector  in  whose  district  the  represen- 
tative has  his  office. 

Description  of  real  property. — In  describing  realty  it 
may  not  be  necessary  to  recite  the  whole  description  on 
the  deed,  but  sufficient  data  should  be  given  in  each 
case  to  permit  an  immediate  and  exact  location  by  a 
Government  officer.  For  example:  "W.  V25  sec-  2,  tp. 
20,  Madison,  111."  j  or,  "House  and  lot,  125,  So.  Main  St., 
Auburn,  N.  Y." 

Accrued  income. — If  accrued  income  has  been  reduced 
to  cash  prior  to  death  and  is  included  in  "cash  in  bank" 
or  otherwise  accounted  for  on  the  return,  it  should  not 
be  set  up  in  the  income  column. 

Gifts  in  contemplation  of  death. — Under  Item  2  there 
must  be  shown  every  gift  or  transfer  of  material  value 
made  or  efifected  by  decedent  within  two  years  prior  to 
day  of  death.  With  the  return  may  be  submitted  such 
evidence  as  the  estate  elects  to  submit  showing  whether 
the  gift  or  transfer  was  made  in  contemplation  of 
death,  and  the  question  of  taxability  will  be  ruled  upon 
by  the  Commissioner  before  the  assessment  against  the 
estate  is  confirmed.    Every  gift  or  transfer  made  in  con- 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  41 1 

templation  of  or  intended  to  take  effect  at  death  must  be 
returned,  regardless  of  the  date  when  made  or  effected. 

Valuation  of  stocks  and  bonds. — The  highest  selling 
price  of  stocks  and  bonds  on  the  day  of  death  fixes  the 
value  to  be  returned ;  or  if  no  sale,  then  the  highest  bid 
price.  If  the  stocks  or  bonds  are  not  listed  on  the  mar- 
ket, the  executor  may  set  up,  from  the  best  evidence 
he  possesses,  a  value  that  he  deems  the  true  value  as 
of  the  day  of  decedent's  death. 

The  Treasury  Department  has  held  that  "the  actual 
value  of  the  real  and  personal  estate  of  decedents  on 
the  date  of  death  should  be  reported  upon  Form  706. 
The  market  value  of  securities  as  of  the  date  of  death 
is,  of  course,  the  proper  value  to  be  returned.  If  de- 
cedent died  on  Sunday  or  a  legal  holiday,  the  market 
value  of  the  securities  on  the  day  preceding  his  death 
should  be  returned.  In  the  absence  of  a  sale  on  the 
date  of  death  or  day  preceding,  the  highest  bid  price 
for  the  security  in  question  is  accepted  as  the  market 
value.  This,  of  course,  refers  to  securities  listed  on  a 
stock  exchange  or  dealt  in  on  the  Curb.  If  the  security 
whose  market  value  is  sought  is  not  listed  on  a  stock 
exchange  or  dealt  in  on  the  Curb,  the  fair  market  value 
may  be  computed  from  actual  sales  made  during  the 
year  preceding  the  date  of  death.  Sales  to  employees, 
sales  for  the  purpose  of  qualifying  directors  or  other 
officers,  sales  pursuant  or  subject  to  an  agreement  re- 
stricting the  re-sale  or  free  action  of  the  purchaser  and 
sales  not  made  within  one  year  preceding  the  date  of 
death  are  not  of  a  character  that  would  justify  their 
use  in  computing  the  value  of  corporate  stock  to  the 
exclusion  of  any  other  evidence.  If  the  stock  is  not 
listed  on  an  exchange,  and  no  record  of  any  bona-fide 
sales  has  been  made  during  the  year  preceding  the  date 
of  decedent's  death,  the  value  of  the  stock  should  be 
computed  upon  the  basis  of  the  net  profits  of  the  cor- 
poration earned  during  the  preceding  five  years. 


412  INCOME    AND    FEDERAL    TAX    REPORTS 

"It  has  been  found,  upon  examination  of  the  returns 
of  net  income  of  a  large  number  of  different  classes  of 
corporations  listed  on  an  exchange,  that  they  earn  ap- 
proximately the  following  rates  in  order  to  make  their 
stock  worth  par: 

Per  cent 

Banking — States  west  of  the  Mississippi  River 8 

States  east  of  the  Mississippi  River 6 

Mercantile    10 

Mining    10 

Industrial    10 

Oil-producing  companies    15 

Oil-refining  companies 10 

Public  utilities  and  railroads 8 

"The  value  of  corporate  stock  of  corporations  which 
have  no  regular  earnings,  such  as  companies  organized 
for  the  purpose  of  developing  and  selling  timber  land, 
mining  property  and  other  real  property,  and  corpora- 
tions which  have  earned  no  profits  in  the  past  five  years, 
or  have  only  been  engaged  in  business  one  or  two  years, 
is  not  always  determined  from  the  earning  capacity  of 
the  corporation.  Therefore,  the  book  value  of  such 
corporations  is  good  evidence  of  the  fair  market  value." 

Community  property.1 — If  the  bulk  of  the  estate  is 
community  property  held  in  legal  partnership  by  de- 
cedent and  spouse,  its  value  should  not  be  shown  under 
Item  4,  but  decedent's  legal  share  should  be  returned 
under  the  several  items,  realty,  stocks  and  bonds,  and 
the  like;  otherwise  the  jointly  owned  property  should 
be  exactly  described  under  Item  4. 

Deductions. — No  item  of  deductions  can  be  taken  in 
excess  of  an  amount  actually  expended,  or,  if  expended, 
in  excess  of  the  limit,  if  any,  set  upon  such  expenditure 
by  the  local  laws  under  which  the  estate  is  being  ad- 
ministered. 

i  For  the  meaning  of  this  term  see  footnote,  page  390. 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  413 

Mortgages. — Mortgages  resting  on  decedent's  property 
should  be  shown  under  "Deductions,"  and  the  full  value 
of  the  mortgaged  realty  should  be  shown  under  Item  1 
of  "Gross  estate."  A  similar  rule  must  be  applied  with 
regard  to  hypothecated  personalty. 

Losses. — It  should  be  noted  that  deductible  losses  are 
strictly  limited  to  those  arising  from  fires,  storms,  ship- 
wreck, or  other  casualty,  and  theft,  when  not  compen- 
sated for,  by  insurance  or  otherwise.  Losses  sustained 
through  sale  or  other  disposition  of  property  at  less 
than  the  inventory  value  thereof  at  the  date  of  de- 
cedent's death  will  not  be  allowed. 

Non-resident's  estate. — A  non-resident's  estate  will  show 
under  items  of  the  "Gross  estate"  only  the  gross  es- 
tate within  the  United  States,  but  will  show  under 
"Deductions"  the  entire  legal  deductions  wherever  in- 
curred. It  will  then  show  in  the  space  subjoined  to 
"Recapitulation"  the  whole  gross  estate  wherever  sit- 
uated and  compute  in  accordance  with  Article  XXIII 
of  Regulations  No.  37,  revised  May,  1917,  the  allowable 
share  of  total  deductions. 

Discount  allowed  for  payment  of  tax  within  one  year. — 
In  order  to  compute  the  5  per  cent,  per  annum  discount 
on  estate  tax  paid  within  one  year  after  the  death  of 
decedent,  determine,  first,  the  date  when  the  payment 
will  actually  be  placed  in  the  collector's  hands,  then 
count  the  actual  number  of  days  from  this  day  to  and 
including  the  day  when  the  tax  is  due.  For  example: 
Date  of  death,  March  3,  1917,  payment  made  Sept.  12, 
1917;  there  would  be  18  days  remaining  in  September, 
October  31,  November  30,  December  31,  January  31, 
February  28,  and  three  days  in  March,  1918,  the  due 
date,  making  a  total  of  172  days  for  which  discount  is 
allowable.  The  discount  on  $1  for  172  days  at  5  per 
cent  is  $0.0235616  (see  table,  page  415) ;  multiply  the 
gross  tax  by  this  amount,  and  the  amount  of  discount 
will  be  the  result. 


414  INCOME   AND    FEDERAL    TAX    REPORTS 

(Extracts  from  T.  D.  2497) 

Instructions,  with  Tables,  Relating  to  the  Computation  of 
the  5  Per  Centum  Discount  to  be  Allowed  on  Estate 
Tax  When  Paid  Before  One  Year  After  the  Death  of 
Decedent. 

Treasury  Department, 

Office  of  Commissioner  of  Internal  Bevenue, 

Washington,  D.  C,  June  4,  1917. 

To  Collectors  of  Internal  Eevenue: 

Numerous  inquiries  have  been  addressed  to  the  bu- 
reau relative  to  the  method  of  computing  the  5  per 
cent,  discount  allowable  on  estate  taxes  where  said 
taxes  are  paid  in  less  than  one  year  after  the  death  of 
the  decedent,  as  to  accepting  partial  payments  of  estate 
taxes  based  on  tentative  returns. 

Tables  showing  the  discount  on  $1  from  1  to  364  days 
have,  therefore,  been  prepared  and  are  hereto  ap- 
pended. Collectors  and  others  concerned  in  computing 
the  discount  should  use  these  tables  exclusively.  Care 
should  be  taken  to  determine  the  number  of  days  re- 
maining in  the  month  during  which  payment  is  made 
and  count  forward  actual  days  until  due  date.  For  ex- 
ample: Date  of  death,  March  4,  1917,  payment  made 
September  13,  1917;  there  would  be  17  days  remaining 
in  September,  October  31,  November  30,  December  31, 
January  31,  February  28,  and  four  days  in  March,  the 
due  date,  making  a  total  of  172  days  for  which  dis- 
count is  allowable. 

Now,  in  computing  the  discount,  find  in  the  table  the 
discount  on  $1  for  172  days  and  multiply  the  gross  tax 
by  this.  The  result  will  be  the  discount  allowable, 
which,  deducted  from  the  full  gross  tax,  will  give  the 
amount  of  tax  on  the  date  payment  is  made. 

Executors  in  computing  discount  will  use  as  the  date 
of  payment  the  date  when  said  payment  will  actually 
be  placed  in  the  collector's  hands,  as  the  statute  fixes 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  415 

that  as  the  date  of  payment  regardless  of  the  date  of 
remittance  or  mailing. 

Frequently,  executors  will  file  a  return  and  request 
the  collector  to  advise  them  of  the  amount  of  tax  due, 
less  discount.  In  such  cases,  the  collector  should  com- 
pute the  discount  to  some  future  date,  advising  the 
executor  of  the  amount  necessary  to  satisfy  the  tax  on 
the  date  named,  making  it  clear  that  the  computation 
is  based  on  the  presumption  that  the  money  will  be  in 
his  (the  collector's)  hands  on  that  date. 

Again,  executors  file  a  tentative  return  and  ask  per- 
mission to  make  a  partial  payment  of  the  tax  due,  usu- 
ally specifying  a  certain  amount,  provided  the  discount 
on  this  amount  is  allowed. 

The  department  sees  no  objection  to  collectors  ac- 
cepting such  partial  payments.  Care  should  be  taken, 
however,  to  compute  the  present  worth  of  such  pay- 
ments in  order  to  determine  how  much  of  the  tax  is 
discharged.  The  computation  in  such  case  should  be 
filed  with  the  tentative  return  in  order  that  when  a 
complete  or  final  return  is  filed  the  balance  of  the  tax 
due  can  readily  be  determined.  The  present  worth 
may  readily  be  found  by  use  of  the  table  as  follows: 
From  $1  deduct  the  amount  of  discount  on  $1  from  date 
of  payment  to  due  date.  Divide  the  amount  of  tax 
paid  by  this  remainder,  and  the  quotient  will  be  the 
present  worth  of  the  amount  of  tax  liability  discharged. 

For  example,  a  partial  payment  of  $300,000  is  ten- 
dered 278  days  before  due  date.  By  the  table  5  per 
cent,  discount  on  $1  for  278  days  is  found  to  be 
$0.0380821;  $1  less  $0.0380821  leaves  $0.9619179;  $300,- 
000  divided  by  $0.9619179  equals  $311,876.82,  the  pres- 
ent worth  or  the  amount  of  tax  liability  discharged  by 
the  partial  payment. 

David   A.    Gates, 

Acting  Commissioner  of  Internal  Revenue. 


416  INCOME   AND    FEDERAL    TAX    REPORTS 

5   PER  CENT  DISCOUNT  ON   $1,    1   DAY  TO  364  DAYS 


Days 

Discount 

Days 

Discount 

Days 

Discount 

Days 

Discount 

1 

$0.0001369 

50 

$0.0068493 

99 

$0.0135616 

148 

$0.0202739 

2 

.0002739 

51 

.0069863 

100 

.01369S6 

149 

.0204109 

3 

.0004109 

52 

.0071232 

101 

.0138356 

150 

.0205479 

4 

.0005479 

53 

.0072602 

102 

.0139726 

151 

.0206849 

5 

.0006849 

54 

.0073972 

103 

.0141095 

152 

.0208219 

6 

.0008219 

55 

.0075342 

104 

.0142465 

153 

.0209589 

7 

.0009589 

56 

.0076712 

105 

.0143835 

154 

.0210958 

8 

.0010958 

57 

.0078082 

106 

.0145205 

155 

.0212328 

9 

.0012328 

58 

.0079452 

107 

.0146575 

156 

.0213698 

10 

.0013698 

59 

.0080821 

108 

.0147945 

157 

.0215068 

11 

.0015068 

60 

.0082191 

109 

.0149315 

158 

.0216438 

12 

.0016438 

61 

.0083561 

110 

.0150684 

159 

.0217808 

13 

.0017808 

62 

.0084931 

111 

.0152054 

160 

.0219178 

14 

.0019178 

63 

.0086301 

112 

.0153424 

161 

.0220547 

15 

.0020547 

64 

.0087671 

113 

.0154794 

162 

.0221917 

16 

.0021917 

65 

.0089041 

114 

.0156164 

163 

.0223287 

17 

.0023287 

66 

.0090410 

115 

.0157534 

164 

.0224657 

18 

.0024657 

67 

.0091780 

116 

.0158904 

165 

.0226027 

19 

.0026027 

68 

.0093150 

117 

.0160273 

166 

.0227397 

20 

.0027397 

69 

.0094520 

118 

.0161643 

167 

.0228767 

21 

.0028767 

70 

.0095890 

119 

.0163013 

168 

.0230136 

22 

.0030136 

71 

.0097260 

120 

.0164383 

169 

.0231506 

23 

.0031506 

72 

.0098630 

121 

.0165753 

170 

.0232876 

24 

.0032876 

73 

.0100000 

122 

.0167123 

171 

.0234246 

25 

.0034246 

74 

.0101369 

123 

.0168493 

172 

.0235616 

26 

.0035616 

75 

.0102739 

124 

.0169863 

173 

.0236986 

27 

.0036986 

76 

.0104109 

125 

.0171232 

174 

.0238356 

28 

.0038356 

77 

.0105479 

126 

.0172602 

175 

.0239726 

29 

.0039726 

78 

.0106849 

127 

.0173972 

176 

.0241095 

30 

.0041095 

79 

.0108219 

128 

.0175342 

177 

.0242465 

31 

.0042465 

80 

.0109589 

129 

.0176712 

178 

.0243835 

32 

.0043835 

81 

.0110958 

130 

.0178082 

179 

.0245205 

33 

.0045205 

82 

.0112328 

131 

.0179452 

180 

.0246575 

34 

.0046575 

83 

.0113698 

132 

.0180821 

181 

.0247945 

35 

.0047945 

84 

.0115068 

133 

.0182191 

182 

.0249315 

36 

.0049315 

85 

.0116438 

134 

.0183561 

183 

.0250684 

37 

.0050684 

86 

.0117808 

135 

.0184931 

184 

.0252054 

38 

.0052054 

87 

.0119178 

136 

.0186301 

185 

.0253424 

39 

.0053424 

88 

.0120547 

137 

.0187671 

186 

.0254794 

40 

.0054794 

89 

.0121917 

138 

.0189041 

187 

.0256164 

41 

.0056164 

90 

.0123287 

139 

.0190410 

188 

.0257534 

42 

.0057534 

91 

.0124657 

140 

.0191780 

189 

.0258904 

43 

.0058904 

92 

.0126027 

141 

.0193150 

190 

.0260273 

44 

.0060273 

93 

.0127397 

142 

.0194520 

191 

.0261643 

45 

.0061643 

94 

.0128767 

143 

.0195890 

192 

.0263013 

46 

.0063013 

95 

.0130136 

144 

.0197260 

193 

.0264383 

47 

.0064383 

96 

.0131506 

145 

.0198630 

194 

.0265753 

48 

.0065753 

97 

.0132876 

146 

.0200000 

195 

.0267123 

49 

.0067123 

98 

.0134246 

147 

.0201369 

196 

.0268493 

FEDERAL    INHERITANCE    OR    ESTATE    TAX 


417 


5  PER  CENT  DISCOUNT  ON  $1,   1  DAY  TO  364  DAYS— Continued 


Days 

Discount 

Days 

Discount 

Days 

Discount 

Days 

Discount 

197 

S0.0269863 

239 

$0.0327397 

281 

$0.0384931 

323 

$0.0442465 

198 

.0271232 

240 

.0328767 

282 

.0386301 

324 

.0443835 

199 

.0272602 

241 

.0330136 

283 

.0387671 

325 

.0445205 

200 

.0273972 

242 

.0331506 

284 

.0389041 

326 

.0446575 

201 

.0275342 

243 

.0332876 

285 

.0390410 

327 

.0447945 

202 

.0276712 

244 

.0334246 

286 

.0391780 

328 

.0449315 

203 

.0278082 

245 

.0335616 

287 

.0393150 

329 

.0450684 

204 

.0279452 

246 

.0336986 

288 

.0394520 

330 

.0452054 

205 

.0280821 

247 

.0338356 

289 

.0395890 

331 

.0453424 

206 

.0282191 

248 

.0339726 

290 

.0397260 

332 

.0454794 

207 

.0283561 

249 

.0341095 

291 

.0398630 

333 

.0456164 

208 

.0284931 

250 

.0342465 

292 

.0400000 

334 

.0457534 

209 

.0286301 

251 

.0343835 

293 

.0401369 

335 

.0458904 

210 

.0287671 

252 

.0345205 

294 

.0402739 

336 

.0460273 

211 

.0289041 

253 

.0346575 

295 

.0404109 

337 

.0461643 

212 

.0290410 

254 

.0347945 

296 

.0405479 

338 

.0463013 

213 

.0291780 

255 

.0349315 

297 

.0406849 

339 

.0464383 

214 

.0293150 

256 

.0350684 

298 

.0408219 

340 

.0465753 

215 

.0294520 

257 

.0352054 

299 

.0409589 

341 

.0467123 

216 

.0295890 

258 

.0353424 

300 

.0410958 

342 

.0468493 

217 

.0297260 

259 

.0354794 

301 

.0412328 

343 

.0469863 

218 

.0298630 

260 

.0356164 

302 

.0413698 

344 

.0471232 

219 

.0300000 

261 

.0357534 

303 

.0415068 

345 

.0472602 

220 

.0301369 

262 

.0358904 

304 

.0416438 

346 

.0473972 

221 

.0302739 

263 

.0360273 

305 

.0417808 

347 

.0475342 

222 

.0304109 

264 

.0361643 

306 

.0419178 

348 

.0476712 

223 

.0305479 

265 

.0363013 

307 

.0420547 

349 

.0478082 

224 

.0306849 

266 

.0364383 

308 

.0421917 

350 

.0479452 

225 

.0308219 

267 

.0365753 

309 

.0423287 

351 

.0480821 

226 

.0309589 

268 

.0367123 

310 

.0424657 

352 

.0482191 

227 

.0310958 

269 

.0368493 

311 

.0426027 

353 

.0483561 

228 

.0312328 

270 

.0369863 

312 

.0427397 

354 

.0484931 

229 

.0313698 

271 

.0371232 

313 

.0428767 

355 

.0486301 

230 

.0315068 

272 

.0372602 

314 

.0430136 

356 

.0487671 

231 

.0316438 

273 

.0373972 

315 

.0431506 

357 

.0489041 

232 

.0317808 

274 

.0375342 

316 

.0432876 

358 

.0490410 

233 

.0319178 

275 

.0376712 

317 

.0434246 

359 

.0491780 

234 

.0320547 

276 

.0378082 

318 

.0435616 

360 

.0493150 

235 

.0321917 

277 

.0379452 

319 

.0436986 

361 

.0494520 

236 

.0323287 

278 

.0380821 

320 

.0438356 

362 

.0495890 

237 

.0324657 

279 

.0382191 

321 

.0439726 

363 

.0497260 

238 

.0326027 

280 

.0383561 

322 

.0441095 

364 

.0498630 

Affidavit. — In  the  affidavit  show  whether  the  return 
submitted  is  tentative  or  final,  by  crossing  out  the  in- 
applicable word. 


418  INCOME   AND    FEDERAL    TAX    REPORTS 

When  return  and  payment  of  tax  is  due. — The  return 
and  tax  payment  must  be  in  the  collector's  hands  before 
the  year  from  the  day  of  death  has  expired. 

Signature. — The  return  should  be  signed  and  sworn 
to  by  all  the  executors. 

RATES  OF  TAX 

How  tax  rate  is  determined. — The  application  of  the 
rates  given  below  depends  upon  the  date  of  decedent's 
death.  The  rates  specified  in  the  original  act,  passed 
September  8,  1916,  are  computed  upon  the  net  estate 
of  every  decedent  dying  on  and  after  September  9, 
1916,  to  and  including  March  2,  1917;  the  rates  pro- 
vided in  the  Amendment  of  March  3,  1917,  apply  to  the 
net  estate  of  every  decedent  dying  on  and  after  March 
3,  1917,  to  and  including  October  3,  1917;  and  the  rates 
provided  in  the  Amendment  of  October  3,  1917,  apply 
to  the  net  estate  of  every  decedent  dying  on  and  after 
October  4,  1917  (T.  D.  2535). 

Exemptions. — The  Amendment  of  October  3,  1917,  ex- 
empts from  the  additional  tax  imposed  by  Title  9 
therein,  the  transfer  of  the  net  estate  of  any  decedent 
dying  while  serving  in  the  military  or  naval  forces  of 
the  United  States  during  the  present  war.  If  death 
results  from  injuries  received  or  disease  contracted  in 
such  service,  within  one  year  after  the  termination  of 
the  war,  the  same  exemption  applies.  The  effect  of  this 
exemption  results  in  subjecting  the  net  estates  of  mili- 
tary and  naval  decedents  to  rates  imposed  in  the  act 
of  March  3,  1917. 


FEDERAL    INHERITANCE    OR    ESTATE    TAX 


419 


RATE  OF  TAXATION  UPON  NET  ESTATES 

Date  of  Death 

Sept.  9,    Mar.  3,      On 

1916,  to  1917,  to    and 

Mar.  2,    Oct.  3,    After 

1917,        1917,    Oct.  4, 

Inclusive  Inclusive  1917 


Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 
Net  estate 


not  exceeding 

$50,000— 

150,000— 

250,000— 

450,000— 

1,000,000— 

2,000,000— 

3,000,000— 

4,000,000— 

5,000,000— 

8,000,000— 

exceeding 


$50,000  @ 

150,000  @ 

250,000  @ 

450,000  @ 

1,000,000  @ 

2,000,000  @ 

3,000,000  @ 

4,000,000  @ 

5,000,000  @ 

8,000,000  @ 

10,000,000  @ 

10,000,000  @ 


1% 

2% 

3% 

4% 

5% 

6% 

7% 

8% 

9% 

10% 

10% 

10% 


m% 

3% 

4^% 

6% 

73^% 

9% 
10K% 
12% 
133^% 
15% 
15% 
15% 


2% 

4% 

6% 

8% 

10% 

12% 

14% 

16% 

18% 

20% 


fg 

25% 


PAYMENT  OF  TAX 

Conditions  relating  to  tax  payment. — The  amount  of  the 
tax  is  based  on  the  return  (Form  706).  The  tax  is  due 
and  payable  one  year  after  the  decedent's  death.  If 
the  tax  is  not  paid  within  ninety  days  thereafter,  in- 
terest is  added  at  the  rate  of  10  per  cent,  per  annum 
from  the  time  of  decedent's  death,  unless,  because  of 
claims  against  the  estate,  necessary  litigation  or  other 
unavoidable  delay,  the  collector  finds  that  the  tax  can- 
not be  determined,  in  which  case  interest  is  added  at 
the  rate  of  6  per  cent,  per  annum  from  the  time  of 
decedent's  death  nntil  the  cause  for  delay  is  removed, 
and  thereafter  at  the  rate  of  10  per  cent,  per  annum. 

Procedure  in  collection  when  no  return  has  been  filed. — 
If,  at  the  expiration  of  ninety  days  after  one  year  from 
decedent's  death,  no  complete  and  final  return  has  been 
made,  the  collector  will  require  a  return  to  be  made  in 
such  manner  that  the  tax  shown  to  be  due  thereon  will 
satisfy,  in  the  collector's  opinion,  all  the  tax  the  estate 
will  be  required  by  law  to  pay.     If  the  amount  of  tax 


420  INCOME   AND   FEDERAL    TAX    REPORTS 

paid  exceeds  the  amount  of  tax  as  finally  determined, 
the  Commissioner  will  refund  the  excess.  If  the  amount 
paid  is  less  than  the  amount  finally  determined,  the 
Commissioner  will  notify  the  executor  of  the  amount  of 
such  excess,  and  interest  will  be  added  from  the  time 
of  notification  to  the  date  of  payment  at  the  rate  of  10 
per  cent  per  annum. 

Discount  for  prepayment. — If  the  tax  is  paid  before  it 
is  due  (one  year  after  decedent's  death)  a  discount  may 
be  deducted  at  the  rate  of  5  per  cent,  per  annum  calcu- 
lated from  the  time  the  payment  is  made  (i.  e.,  when 
actually  received  by  the  collector)  to  the  date  when  the 
tax  is  due. 

Advance  payment  of  tax  in  an  estimated  lump  amount 
will  not  be  accepted.  The  initial  tax  payment  must  be 
based  upon  a  return  (either  tentative  or  final)  (see  "re- 
turns," page  408  of  this  chapter),  showing  reasonably 
complete  and  accurate  figures  for  every  item  of  gross 
estate  and  deductions. 

Suit  for  collection  of  tax. — As  stated  above,  the  tax  is 
due  one  year  after  decedent's  death,  and  if  not  paid 
within  ninety  days  thereafter  interest  will  be  added 
from  the  day  of  decedent's  death.  If,  however,  the  tax 
is  not  paid  within  60  days  after  it  is  due,  the  collector 
shall,  unless  there  is  reasonable  cause  for  further  de- 
lay, bring  suit  for  collection,  and,  upon  decree,  sell  the 
property  and  satisfy  the  tax  and  expenses. 

Tax  is  a  lien  upon  estate. — The  tax  shown  to  be  due 
upon  a  final  return  is  a  lien  for  ten  years,  or  until 
sooner  paid,  upon  the  entire  gross  estate,  except  such 
part  as  is  used  for  the  payment  of  charges  and  expenses 
of  administration.  The  lien  follows  the  property  into 
the  hands  of  distributees  and  bona  fide  purchasers  for 
value.  If,  after  the  tax  has  been  paid  upon  a  return 
and  accepted  by  the  commissioner  as  final,  it  later  ap- 
pears that  an  additional  tax  is  due,  the  lien  for  the 
additional  tax  rests  upon  the  property  in  the  hands  of 


FEDERAL    INHERITANCE    OR    ESTATE    TAX  ■  421 

decedent's  executors  or  beneficiaries,  and  does  not  rest 
upon  any  part  of  decedent's  property  which  may  have 
been  sold  to  a  bona  fide  purchaser. 

A  lien  for  the  amount  of  the  tax  rests  also  upon  the 
value  of  testator's  interest  in  any  property  transferred 
by  him  in  trust  at  any  time  to  a  trustee  in  contempla- 
tion of  death. 

PENALTIES 

Penalty  for  neglect.  —  Any  executor,  administrator, 
beneficiary,  heir,  donee,  transferee,  trustee,  fiduciary, 
banking  institution,  safe  deposit  company,  paying  agent, 
transfer  agent,  register,  or  other  agent  or  representa- 
tive of  a  decedent's  estate  who  shall  fail  to  file  the  no- 
tice (Forms  704,  705  and  714,  as  the  case  may  be),  or 
the  return  (Form  706),  when  required,  shall  be  liable 
to  a  fine  not  to  exceed  $500,  to  be  recovered,  with  costs 
of  suit,  in  a  civil  action  in  the  name  of  the  United 
States.  A  similar  penalty  is  likewise  imposed  upon 
anyone  refusing  to  exhibit  any  record,  file  or  paper 
containing  or  supposed  to  contain  information  concern- 
ing a  decedent's  estate  upon  the  request  of  the  commis- 
sioner, or  his  duly  authorized  agent. 

Penalty  for  fraud. — Anyone  knowingly  making  a  false 
statement  in  any  notice  or  return  required  to  be  filed 
shall  be  liable  to  a  penalty  of  not  exceeding  $5,000,  or 
imprisonment  not  exceeding  one  year,  or  both,  in  the 
discretion  of  the  court. 


CHAPTER  XVII 
ESTATE  TAX  LAW 

BEING   TITLE   II    OF    "AN    ACT  TO   INCREASE   THE 
REVENUE  AND  FOR  OTHER  PURPOSES,"   AP- 
PROVED   SEPTEMBER  8,  1916   (PUBLIC— 
No.     271— 64th    CONGRESS)     IN 
EFFECT  SEPTEMBER  9, 1916 


TITLE   II.— ESTATE   TAX. 

Definition. — Sec.  200.     That  when  used  in  this  title — 

The  term  "person"  includes  partnerships,  corpora- 
tions, and  associations; 

The  term  "United  States"  means  only  the  States,  the 
Territories  of  Alaska  and  Hawaii,  and  the  District  of 
Columbia ; 

The  term  "executor"  means  the  executor  or  admin- 
istrator of  the  decedent,  or,  if  there  is  no  executor  or 
administrator,  any  person  who  takes  possession  of  any 
property  of  the  decedent;  and 

The  term  "collector"  means  the  collector  of  internal 
revenue  of  the  district  in  which  was  the  domicile  of  the 
decedent  at  the  time  of  his  death,  or,  if  there  was  no 
such  domicile  in  the  United  States,  then  the  collector  of 
the  district  in  which  is  situated  the  part  of  the  grost 
estate  of  the  decedent  in  the  United  States,  or,  if  such 
part  of  the  gross  estate  is  situated  in  more  than  one 
district,  then  the  collector  of  internal  revenue  at  Balti- 
more, Maryland. 

422 


ESTATE    TAX    LAW  423 

Rate  of  tax. — Sec.  201.  That  a  tax  (hereinafter  in 
this  title  referred  to  as  the  tax),  equal  to  the  following 
percentages  of  the  value  of  the  net  estate,  to  be  deter- 
mined as  provided  in  section  two  hundred  and  three,  is 
hereby  imposed  upon  the  transfer  of  the  net  estate  of 
every  decedent  dying  after  the  passage  of  this  Act, 
whether  a  resident  or  non-resident  of  the  United  States : 

One  per  centum  of  the  amount  of  such  net  estate 
not  in  excess  of  $50,000; 

Two  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $50,000  and  does  not  exceed  $150,000; 

Three  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $150,000  and  does  not  exceed  $250,000; 

Four  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $250,000  and  does  not  exceed  $450,000; 

Five  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $450,000  and  does  not  exceed  $1,000,000; 

Six  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $1,000,000  and  does  not  exceed  $2,000,000 ; 

Seven  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $2,000,000  and  does  not  exceed  $3,000,000 ; 

Eight  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $3,000,000  and  does  not  exceed  $4,000,000 ; 

Nine  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $4,000,000  and  does  not  exceed  $5,000,000 ; 
and 

Ten  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $5,000,000. 

Valuation  of  gross  estate. — Sec.  202.  That  the  value  of 
the  gross  estate  of  the  decedent  shall  be  determined  by 
including  the  value  at  the  time  of  his  death  of  all  prop- 
erty, real  or  personal,  tangible  or  intangible,  wherever 
situated : 

(a) To  the  extent  of  the  interest  therein  of  the  de- 
cedent at  the  time  of  his  death  which  after  his  death 
is   subject  to  the  payment  of  the  charges   against  his 


424  INCOME    AND    FEDERAL    TAX    REPORTS 

estate  and  the  expenses  of  its  administration  and  is 
subject  to  distribution  as  part  of  his  estate. 

Transfers  of  property  made  in  contemplation  of  death. — 
(b)  To  the  extent  of  any  interest  therein  of  which  the 
decedent  has  at  any  time  made  a  transfer,  or  with  re- 
spect to  which  he  has  created  a  trust,  in  contemplation 
of  or  intended  to  take  effect  in  possession  or  enjoyment 
at  or  after  his  death,  except  in  case  of  a  bona  fide  sale 
for  a  fair  consideration  in  money  or  money's  worth.  Any 
transfer  of  a  material  part  of  his  property  in  the  na- 
ture of  a  final  disposition  or  distribution  thereof,  made 
by  the  decedent  within  two  years  prior  to  his  death 
without  such  a  consideration,  shall,  unless  shown  to  the 
contrary,  be  deemed  to  have  been  made  in  contempla- 
tion of  death  within  the  meaning  of  this  title;  and 

Joint  interests  held  by  decedent  and  others. — (c)  To 
the  extent  of  the  interest  therein  held  jointly  or  as 
tenants  in  the  entirety  by  the  decedent  and  any  other 
person,  or  deposited  in  banks  or  other  institutions  in 
their  joint  names  and  payable  to  either  or  the  survivor; 
except  such  part  thereof  as  may  be  shown  to  have  origi- 
nally belonged  to  such  other  person  and  never  to  have 
belonged  to  the  decedent. 

Disposition  of  stock  in  domestic  corporations  owned  by 
decedent. — For  the  purpose  of  this  title  stock  in  a 
domestic  corporation  owned  and  held  by  a  non-resident 
decedent  shall  be  deemed  property  within  the  United 
States,  and  any  property  of  which  the  decedent  has 
made  a  transfer  or  with  respect  to  which  he  has  created 
a  trust,  within  the  meaning  of  subdivision  (b)  of  this 
section,  shall  be  deemed  to  be  situated  in  the  United 
States,  if  so  situated  either  at  the  time  of  the  transfer 
or  the  creation  of  the  trust,  or  at  the  time  of  the  dece- 
dent's death. 

Valuation  of  net  estate. — Sec.  203.  That  for  the  pur- 
pose of  the  tax  the  value  of  the  net  estate  shall  be 
determined — 


ESTATE    TAX    LAW  425 

(a)  In  the  case  of  a  resident,  by  deducting  from  the 
value  of  the  gross  estate — 

(1)  Such  amounts  for  funeral  expenses,  administra- 
tion expenses,  claims  against  the  estate,  unpaid  mort- 
gages, losses  incurred  during  the  settlement  of  the 
estate  arising  from  fires,  storms,  shipwreck,  or  other 
casualty,  and  from  theft,  when  such  losses  are  not 
compensated  for  by  insurance  or  otherwise,  support 
during  the  settlement  of  the  estate  of  those  dependent 
upon  the  decedent,  and  such  other  charges  against  the 
estate,  as  are  allowed  by  the  laws  of  the  jurisdiction, 
whether  within  or  without  the  United  States,  under 
which  the  estate  is  being  administered;  and 

(2)  An  exemption  of  $50,000; 

(b)  In  the  case  of  a  non-resident,  by  deducting  from 
the  value  of  that  part  of  his  gross  estate  which  at  the 
time  of  his  death  is  situated  in  the  United  States  that 
proportion  of  the  deductions  specified  in  paragraph 
(1)  of  subdivision  (a)  of  this  section  which  the  value 
of  such  part  bears  to  the  value  of  his  entire  gross 
estate,  wherever  situated.  But  no  deductions  shall  be 
allowed  in  the  case  of  a  non-resident  unless  the 
executor  includes  in  the  return  required  to  be  filed 
under  section  two  hundred  and  five  the  value  at  the 
time  of  his  death  of  that  part  of  the  gross  estate  of 
the  non-resident  not  situated  in  the  United  States. 

Date  tax  becomes  due. — Sec.  204.  That  the  tax  shall 
be  due  one  year  after  the  decedent's  death.  If  the  tax 
is  paid  before  it  is  due  a  discount  at  the  rate  of  five 
per  centum  per  annum,  calculated  from  the  time  pay- 
ment is  made  to  the  date  when  the  tax  is  due,  shall 
be  deducted.  If  the  tax  is  not  paid  within  ninety  days 
after  it  is  due  interest  at  the  rate  of  ten  per  centum 
per  annum  from  the  time  of  the  decedent's  death  shall 
be  added  as  part  of  the  tax,  unless  because  of  claims 
against  the  estate,  necessary  litigation,  or  other  un- 
avoidable delay  the  collector  finds  that  the  tax  can  not 


426  INCOME    AND    FEDERAL    TAX    REPORTS 

be  determined,  in  which  case  the  interest  shall  be  at 
the  rate  of  six  per  centum  per  annum  from  the  time  of 
the  decedent's  death  until  the  cause  of  such  delay  is 
removed,  and  thereafter  at  the  rate  of  ten  per  centum 
per  annum.  Litigation  to  defeat  the  payment  of  the 
tax  shall  not  be  deemed  necessary  litigation. 

Executor  to  qualify  and  file  return. — Sec.  205.  That 
the  executor,  within  thirty  days  after  qualifying  as 
such,  or  after  coming  into  possession  of  any  property 
of  the  decedent,  whichever  event  first  occurs,  shall  give 
written  notice  thereof  to  the  collector.  The  executor 
shall  also,  at  such  times  and  in  such  manner  as  may 
be  required  by  the  regulations  made  under  this  title, 
file  with  the  collector  a  return  under  oath  in  duplicate, 
setting  forth  (a)  the  value  of  the  gross  estate  of  the 
decedent  at  the  time  of  his  death,  or,  in  case  of  a 
non-resident,  of  that  part  of  his  gross  estate  situated 
in  the  United  States;  (b)  the  deductions  allowed 
under  section  two  hundred  and  three;  (c)  the  value  of 
the  net  estate  of  the  decedent  as  defined  in  section 
two  hundred  and  three;  and  (d)  the  tax  paid  or  pay- 
able thereon;  or  such  part  of  such  information  as  may 
at  the  time  be  ascertainable  and  such  supplemental  data 
as  may  be  necessary  to  establish  the  correct  tax.  Return 
shall  be  made  in  all  cases  of  estates  subject  to  the  tax  or 
where  the  gross  estate  at  the  death  of  the  decedent 
exceeds  $60,000,  and  in  the  case  of  the  estate  of  every 
non-resident  any  part  of  whose  gross  estate  is  situated 
in  the  United  States.  If  the  executor  is  unable  to 
make  a  complete  return  as  to  any  part  of  the  gross 
estate  of  the  decedent,  he  shall  include  in  his  return 
a  description  of  such  part  and  the  name  of  every 
person  holding  a  legal  or  beneficial  interest  therein, 
and  upon  notice  from  the  collector  such  person  shall 
in  like  manner  make  a  return  as  to  such  part  of  the 
gross  estate.  The  Commissioner  of  Internal  Revenue 
shall  make  all  assessments  of  the  tax  under  the  author- 


ESTATE    TAX    LAW  427 

ity  of  existing  administrative  special  and  general  pro- 
visions of  law  relating  to  the  assessment  and  collection 
of  taxes. 

Cases  in  which  collector  shall  make  return. — Sec.  206. 
That  if  no  administration  is  granted  upon  the  estate 
of  a  decedent,  or  if  no  return  is  filed  as  provided  in 
section  two  hundred  and  five,  or  if  a  return  contains 
a  false  or  incorrect  statement  of  a  material  fact,  the 
collector  or  deputy  collector  shall  make  a  return  and 
the  Commissioner  of  Internal  Kevenue  shall  assess 
the  tax  thereon. 

Procedure  in  tax  payment. — Sec.  207.  That  the  execu- 
tor shall  pay  the  tax  to  the  collector  or  deputy  collec- 
tor. If  for  any  reason  the  amount  of  the  tax  can  not 
be  determined,  the  payment  of  a  sum  of  money  suffi- 
cient, in  the  opinion  of  the  collector,  to  discharge  the 
tax  shall  be  deemed  payment  in  full  of  the  tax,  except 
as  in  this  section  otherwise  provided.  If  the  amount 
so  paid  exceeds  the  amount  of  the  tax  as  finally  deter- 
mined, the  Commissioner  of  Internal  Revenue  shall 
refund  such  excess  to  the  executor.  If  the  amount  of 
the  tax  as  finally  determined  exceeds  the  amount  so 
paid  the  commissioner  shall  notify  the  executor  of 
the  amount  of  such  excess.  From  the  time  of  such 
notification  to  the  time  of  the  final  payment  of  such 
excess  part  of  the  tax,  interest  shall  be  added  thereto 
at  the  rate  of  ten  per  centum  per  annum,  and  the 
amount  of  such  excess  shall  be  a  lien  upon  the  entire 
gross  estate,  except  such  part  thereof  as  may  have 
been  sold  to  a  bona  fide  purchaser  for  a  fair  consid- 
eration in  money  or  money's  worth. 

The  collector  shall  grant  to  the  person  paying  the  tax 
duplicate  receipts,  either  of  which  shall  be  sufficient 
evidence  of  such  payment,  and  shall  entitle  the  execu 
tor  to  be  credited  and  allowed  the  amount  thereof  by 
any  court  having  jurisdiction  to  audit  or  settle  his 
accounts. 


428  INCOME    AND    FEDERAL    TAX    REPORTS 

Collection  by  sale  of  property  in  case  of  default. — Sec. 
208.  That  if  the  tax  herein  imposed  is  not  paid  within 
sixty  days  after  it  is  due,  the  collector  shall,  unless 
there  is  reasonable  cause  for  further  delay,  com- 
mence appropriate  proceedings  in  any  court  of  the 
United  States,  in  the  name  of  the  United  States, 
to  subject  the  property  of  the  decedent  to  be  sold 
under  the  judgment  or  decree  of  the  court.  Prom 
the  proceeds  of  such  sale  the  amount  of  the  tax. 
together  with  the  costs  and  expenses  of  every  descrip- 
tion to  be  allowed  by  the  court,  shall  be  first  paid,  and 
the  balance  shall  be  deposited  according  to  the  order  of 
the  court,  to  be  paid  under  its  direction  to  the  person 
entitled  thereto.  If  the  tax  or  any  part  thereof  is  paid 
by,  or  collected  out  of  that  part  of  the  estate  passing  to 
or  in  the  possession  of,  any  person  other  than  the  execu- 
tor in  his  capacity  as  such,  such  person  shall  be  en- 
titled to  reimbursement  out  of  any  part  of  the  estate 
still  undistributed  or  by  a  just  and  equitable  contribu- 
tion by  the  persons  whose  interest  in  the  estate  of  the 
decedent  would  have  been  reduced  if  the  tax  had  been 
paid  before  the  distribution  of  the  estate  or  whose  in- 
terest is  subject  to  equal  or  prior  liability  for  the  pay- 
ment of  taxes,  debts,  or  other  charges  against  the  estate, 
it  being  the  purpose  and  intent  of  this  title  that  so  far 
as  is  practicable  and  unless  otherwise  directed  by  the 
will  of  the  decedent  the  tax  shall  be  paid  out  of  the 
estate  before  its  distribution. 

Tax  is  a  lien  against  decedent's  gross  estate. — Sec.  209. 
That  unless  the  tax  is  sooner  paid  in  full,  it  shall  be  a 
lien  for  ten  years  upon  the  gross  estate  of  the  decedent, 
except  that  such  part  of  the  gross  estate  as  is  used  for 
the  payment  of  charges  against  the  estate  and  expenses 
of  its  administration,  allowed  by  any  court  having  juris- 
diction thereof,  shall  be  divested  of  such  lien. 

If  the  decedent  makes  a  transfer  of,  or  creates  a  trust 
with  respect  to,  any  property  in  contemplation  of  or  in- 


ESTATE    TAX    I, AW  429 

tended  to  take  effect  in  possession  or  enjoyment  at  or 
after  his  death  (except  in  the  case  of  a  bona  fide  sale 
for  a  fair  consideration  in  money  or  money's  worth)  and 
if  the  tax  in  respect  thereto  is  not  paid  when  due,  the 
transferee  or  trustee  shall  be  personally  liable  for  such 
tax,  and  such  property,  to  the  extent  of  the  decedent's 
interest  therein  at  the  time  of  such  transfer,  shall  be 
subject  to  a  like  lien  equal  to  the  amount  of  such  tax. 
Any  part  of  such  property  sold  by  such  transferee  or 
trustee  to  a  bona  fide  purchaser  for  a  fair  consideration 
in  money  or  money's  worth  shall  be  divested  of  the  lien 
and  a  like  lien  shall  then  attach  to  all  the  property  of 
such  transferee  or  trustee,  except  any  part  sold  to  a 
bona  fide  purchaser  for  a  fair  consideration  in  money  or 
money's  worth. 

Penalties  for  false  statement  and  for  withholding  infor- 
mation.— Sec.  210.  That  whoever  knowingly  makes  any 
false  statement  in  any  notice  or  return  required  to  be 
filed  by  this  title  shall  be  liable  to  a  penalty  of  not  ex- 
ceeding $5,000,  or  imprisonment  not  exceeding  one  year, 
or  both,  in  the  discretion  of  the  court. 

Whoever  fails  to  comply  with  any  duty  imposed  upon 
him  by  section  two  hundred  and  five,  or,  having  in  his 
possession  or  control  any  record,  file,  or  paper,  contain- 
ing or  supposed  to  contain  any  information  concerning 
the  estate  of  the  decedent,  fails  to  exhibit  the  same  upon 
request  to  the  Commissioner  of  Internal  Eevenue  or  any 
collector  or  law  officer  of  the  United  States,  or  his  duly 
authorized  deputy  or  agent,  who  desires  to  examine  the 
same  in  the  performance  of  his  duties  under  this  title, 
shall  be  liable  to  a  penalty  of  not  exceeding  $500,  to  be 
recovered,  with  costs  of  suit,  in  a  civil  action  in  the 
name  of  the  United  States. 

Administration  of  law. — Sec.  211.  That  all  administra- 
tive, special,  and  general  provisions  of  law,  including 
the  laws  in  relation  to  the  assessment  and  collection  of 
taxes,  not  heretofore   specifically   repealed   are   hereby 


430  INCOME    AND    FEDERAL    TAX    REPORTS 

made  to  apply  to  this  title  so  far  as  applicable  and  not 
inconsistent  with  its  provisions. 

Sec.  212.  That  the  Commissioner  of  Internal  Reve- 
nue, with  the  approval  of  the  Secretary  of  the  Treas- 
ury, shall  make  such  regulations,  and  prescribe  and  re- 
quire the  use  of  such  books  and  forms,  as  he  may  deem 
necessary  to  carry  out  the  provisions  of  this  title. 

TITLE  IX. 

Invalidating  clause. — Sec.  900.  That  if  any  clause, 
sentence,  paragraph,  or  part  of  this  Act  shall  for  any 
reason  be  adjudged  by  any  court  of  competent  jurisdic- 
tion to  be  invalid,  such  judgment  shall  not  affect,  im- 
pair, or  invalidate  the  remainder  of  said  Act,  but  shall 
be  confined  in  its  operation  to  the  clause,  sentence,  para- 
graph, or  part  thereof  directly  involved  in  the  contro 
versy  in  which  such  judgment  shall  have  been  rendered. 

When  Act  takes  effect — conflicting  Acts  repealed. — Sec. 
902.  That  unless  otherwise  herein  specially  provided 
this  Act  shall  take  effect  on  the  day  following  its  pas- 
sage, and  all  provisions  of  any  Act  or  Acts  inconsistent 
with  the  provisions  of  this  Act,  are  hereby  repealed. 

Approved  by  the  President,  September  8,  1916. 

TITLE  IX.— WAR  ESTATE  TAX.1 

Rate  of  tax  upon  transfer  of  decedent's  estate. — Sec.  900 
[of  the  general  revenue  Act  of  which  this  Title  is  a 
part].  That  in  addition  to  the  tax  imposed  by  section 
two  hundred  and  one  of  the  Act  entitled  "An  Act  to  in- 
crease the  revenue,  and  for  other  purposes,"  approved 
September  eighth,  nineteen  hundred  and  sixteen,  as 
amended. 

i  War  Estate  Tax.  Being  Title  IX  of  "An  Act  to  Provide  Revenue  to 
Defray  War  Expenses  and  for  other  Purposes,"  Approved  October  3,  1917. 
(Public — No.  50 — 65th  Congress.)  In  effect  October  4,  1917,  unless  other- 
wise specially  provided. 


ESTATE    TAX    LAW  431 

(a)  A  tax  equal  to  the  following  percentages  of  its 
value  is  hereby  imposed  upon  the  transfer  of  each  net 
estate  of  every  decedent  dying  after  the  passage  of  this 
Act,  the  transfer  of  which  is  taxable  under  such  section 
(the  value  of  such  net  estate  to  be  determined  as  pro- 
vided in  Title  II  of  such  Act  of  September  eighth,  nine- 
teen hundred  and  sixteen) : 

One-half  of  one  per  centum  of  the  amount  of  such 
net  estate  not  in  excess  of  $50,000; 

One  per  centum  of  the  amount  by  which  such  net 
estate   exceeds  $50,000  and  does  not  exceed  $150,000; 

One  and  one-half  per  centum  of  the  amount  by  which 
such  net  estate  exceeds  $150,000  and  does  not  exceed 
$250,000; 

Two  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $250,000  and  does  not  exceed  $450,000; 

Two  and  one-hali  per  centum  of  the  amount  by  which 
such  net  estate  exceeds  $450,000  and  does  not  exceed 
$1,000,000; 

Three  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $1,000,000  and  does  not  exceed  $2,000,000 ; 

Three  and  one-half  per  centum  of  the  amount  by  which 
such  net  estate  exceeds  $2,000,000  and  does  not  exceed 
$3,000,000; 

Four  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $3,000,000  and  does  not  exceed  $4,000,000 ; 

Four  and  one-half  per  centum  of  the  amount  by  which 
such  net  estate  exceeds  $4,000,000  and  does  not  exceed 
$5,000,000; 

Five  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $5,000,000  and  does  not  exceed  $8,000,000 ; 

Seven  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $8,000,000  and  does  not  exceed  $10,000,- 
000;  and 

Ten  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $10,000,000. 


432  INCOME    AND    FEDERAL    TAX    REPORTS 

Estate  of  soldiers  and  marines  exempt. — Sec.  901.  That 
the  tax  imposed  by  this  title  shall  not  apply  to  the 
transfer  of  the  net  estate  of  any  decedent  dying  while 
serving  in  the  military  or  naval  forces  of  the  United 
States,  during  the  continuance  of  the  war  in  which  the 
United  States  is  now  engaged,  or  if  death  results  from 
injuries  received  or  disease  contracted  in  such  service, 
within  one  year  after  the  termination  of  such  war.  For 
the  purposes  of  this  section  the  termination  of  the  war 
shall  be  evidenced  by  the  proclamation  of  the  President. 

Approved  by  the  President,  October  3,  1917. 

Taxability  of  United  States  Bonds,  Treasury  Certificates  of 

Indebtedness   and   War    Saving    Certificates   Issued 

Under  Authority  of  Act  of  September  24,  1917. 

TITLE   III.— ESTATE    TAX.1 

Sec.  300  [of  the  general  revenue  Act  of  which  this 
Title  is  a  part].  That  section  two  hundred  and  one, 
Title  II,  of  the  Act  entitled  "An  Act  to  increase  the  rev- 
enue, and  for  other  purposes,"  approved  September 
eighth,  nineteen  hundred  and  sixteen,  be,  and  the  same 
is  hereby,  amended  to  read  as  follows: 

"Sec.  201.  That  a  tax  (hereinafter  in  this  title  re- 
ferred to  as  the  tax),  equal  to  the  following  percentages 
of  the  value  of  the  net  estate,  to  be  determined  as  pro- 
vided in  section  two  hundred  and  three,  is  hereby  im- 
posed upon  the  transfer  of  the  net  estate  of  every  de- 
cedent dying  after  the  passage  of  this  Act,  whether  a 
resident  or  non-resident  of  the  United  States : 

"One  and  one-half  per  centum  of  the  amount  of  such 
net  estate  not  in  excess  of  $50,000 ; 

i  Amendment  Number  I.  Being  Title  III  of  "An  Act  to  Provide  Increased 
Revenue  to  Defray  the  Expenses  of  the  Increased  Appropriations  for  the 
Army  and  Navy  and  the  Extensions  of  Fortifications,  and  for  Other  Pur- 
poses," Approved  March  3,  1917.  (Public — No.  377 — 64th  Congress.)  In 
effect  March  3,  1917. 


ESTATE    TAX    LAW  433 

"Three  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $50,000  and  does  not  exceed  $150,000; 

"Four  and  one-half  per  centum  of  the  amount  by 
which  such  net  estate  exceeds  $150,000  and  does  not  ex- 
ceed $250,000; 

"Six  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $250,000  and  does  not  exceed  $450,000; 

"Seven  and  one-half  per  centum  of  the  amount  by 
which  such  net  estate  exceeds  $450,000  and  does  not  ex- 
ceed $1,000,000; 

"Nine  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $1,000,000  and  does  not  exceed  $2,000,000 ; 

"Ten  and  one-half  per  centum  of  the  amount  by  which 
such  net  estate  exceeds  $2,000,000  and  does  not  exceed 
$3,000,000; 

"Twelve  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $3,000,000  and  does  not  exceed  $4,000,000 ; 

"Thirteen  and  one-half  per  centum  of  the  amount  by 
which  such  net  estate  exceeds  $4,000,000  and  does  not 
exceed  $5,000,000;  and 

"Fifteen  per  centum  of  the  amount  by  which  such  net 
estate  exceeds  $5,000,000." 

Sec.  301.  That  the  tax  on  the  transfer  of  the  net 
estate  of  decedents  dying  between  September  eighth, 
nineteen  hundred  and  sixteen,  and  the  passage  of  this 
Act  shall  be  computed  at  the  rates  originally  prescribed 
in  the  Act  approved  September  eighth,  nineteen  hundred 
and  sixteen. 

Approved  by  the  President,  March  3,  1917. 


CHAPTER  XVU1 
MUNITION  MANUFACTURER'S  TAX 

Origin  of  Munition  Manufacturer's  Tax. — The  Munition 
Manufacturer's  Tax  is  Title  III  of  "An  Act  to  In- 
crease the  Revenue  and  for  Other  Purposes,"  ap- 
proved September  8,  1916.  Its  original  purpose  was 
to  place  an  excise  tax  on  the  profits  derived  from  the 
manufacture  and  sale  of  certain  munitions  and  muni- 
tions parts  manufactured  in  the  United  States  and 
sold  to  foreign  governments.  A  ruling  has  been  made, 
however,  that  the  tax  applies  also  to  profits  from 
the  manufacture  and  sale  of  munitions  sold  to  the 
United  States  or  to  any  other  purchaser  for  other 
than  industrial  purposes. 

Time  during  which  law  is  effective. — The  law  became 
effective  September  9,  1916,  but  was  retroactive  to 
January  1,  1916,  the  first  taxable  year  being  the  twelve 
months  ended  December  31,  1916.  It  was  provided 
(section  301,  subdivision  [2])  that  the  tax  should 
cease  to  be  of  effect  one  year  after  the  termination 
of  the  present  European  war,  but  this  provision  was 
changed  by  an  amendment  inserted  in  the  Act  of 
October  3,  1917,  which  specifies  January  1,  1918,  as 
the  date  upon  which  the  tax  shall  terminate. 

Manufacturer  pays  the  tax. — The  tax  is  to  be  paid  by 
every  person  manufacturing  within  the  United  States 
any  of  the  articles  enumerated  in  section  301,  "per- 
son" including,  under  Title  III,  partnerships,  corpora- 
tions and  associations,  and  "United  States"  meaning 
only  the  States,  the  Territories  of  Alaska  and  Hawaii 
and  the  District  of  Columbia.     It  is  to  be  noted  that 

434 


MUNITION    MANUFACTURER'S    TAX  435 

the  tax  is  only  upon  the  manufacturer  or  his  agent 
and  not  upon  dealers  or  brokers  unless  they  are  agents 
of  the  manufacturer,  since  the  tax  on  any  article  is 
payable  only  once. 

In  the  case  of  a  business  which  ceases  during  a  cal- 
endar year,  the  tax  will  be  assessed  against  the  per- 
son who  owned  or  carried  on  the  business  at  the  time 
it  ceased,  or  against  his  agent,  if  he  had  an  agent, 
carrying  on  the  business.  In  either  case  the  person 
against  whom  the  tax  is  assessed  will  be  held  liable  for 
its  payment  and  to  any  penalties  that  may  attach  to 
his  failure  to  comply  with  the  provisions  of  the  law. 

Assemblage  of  parts  is  construed  as  manufacture. — The 
Commissioner  of  Internal  Revenue,  in  a  letter  dated 
January  18,  1917,  holds  that  a  manufacturer  of  muni- 
tions, under  the  Munitions  Tax  Law,  includes  one  who 
collects  the  parts,  whether  complete  or  partially  com- 
plete, and,  by  assembling  such  parts,  constructs  a  fin- 
ished and  completed  article  ready  for  use,  and  that  the 
net  profits  from  the  sale  by  him  of  the  munitions  so 
manufactured  will  be  subject  to  the  tax  imposed  by 
this  title. 

Basis  of  the  tax. — The  basis  of  the  tax  is  the  entire 
net  profits  actually  received  and  accrued  from  the  sale 
or  disposition  of  such  articles  manufactured  within  the 
United  States  from  January  1,  1916,  to  January  1, 
1918.  Profits  received  subsequently  on  contracts  com- 
pleted before  January  1,  1916,  are  not  included.  In 
the  ease  of  contracts  only  partially  performed  at  that 
date,  the  tax  attaches  upon  all  the  profits  resulting 
from  such  contract  received  after  January  1,  1916. 

Rate  of  tax. — The  rate  of  tax  under  the  original  Act 
was  12y2  per  cent,  which  rate  applied  in  1916.  The 
rate  for  the  tax  collectible  on  profits  returned  in  1917, 
however,  is  10  per  cent,  as  provided  in  the  amendment 
of  October  3,  1917. 

The  changes  in  the  law,  reducing  the  rate  and  pro- 


436  INCOME   AND    FEDERAL    TAX    REPORTS 

viding  for  the  termination  of  the  tax  January  1,  1918, 
were  made  as  a  result  of  (1)  the  new  conditions  due  to 
the  participation  of  the  United  States  in  the  war  and 
(2)  the  imposition  of  the  War  Excess  Profits  Tax. 

Computation  of  Tax. — From  the  foregoing  general 
summary  it  will  be  seen  that  the  tax  is  a  given  per- 
centage of  net  profits  derived  from  the  manufacture 
and  sale  of  certain  articles  during  a  specified  period 
of  time.  The  problem  of  computing  the  tax  due  in  any 
specific  case,  accordingly,  resolves  itself  into  a  deter- 
mination of  (1)  what  articles  are  taxable;  (2)  what 
deductions  may  be  allowed  from  gross  income  received 
from  the  manufacture  and  sale  of  those  articles  in 
order  to  ascertain  the  taxable  net  profits  and  (3)  what 
rate  of  tax  applies  during  the  period  in  which  they 
were  produced  and  sold,  together  with  a  determina- 
tion of  the  actual  time  at  which  a  contract  has  been 
completed  and  the  profits  therefrom  accordingly  (1) 
exempt,  (2)  subject  to  12y2  per  cent  tax  (3)  10  per 
cent  tax,  or  again  exempt,  due  to  the  expiration  of 
the  taxable  period,  which  ends  January  1,  1918. 

These  separate  phases  of  the  problem  of  computing 
the  actual  amount  of  tax  payable  will  be  considered 
in  the  following  pages  of  this  chapter. 

Articles  the  net  profit  derived  from  the  manufacture 
and  sale  of  which  is  taxable. — The  articles  enumerated 
in  section  301,  the  net  profit  derived  from  the  manu- 
facture and  sale  or  disposition  of  which  is  taxable, 
will  hereafter,  for  convenience,  be  referred  to  as  "tax- 
able articles,"  and  "exempt"  will  mean  that  the  manu- 
facturer of  such  articles  will  not  be  held  liable  for 
the  tax.  In  the  following  sections,  the  above  referred 
to  "taxable  articles"  will  be  defined  where  necessary 
and  such  information  given  concerning  them  as  will 
enable  the  manufacturer  of  the  same  or  a  similar 
article  to  determine  whether  or  not  he  is  liable  for  the 
payment  of  a  munition  manufacturer's  tax. 


MUNITION    MANUFACTURER'S    TAX  437 

Eeferences  given  herein,  as  "Art.  14"  below,  are  to 
articles  of  Treasury  Department  Kegulations  39. 

Exemption  of  articles  made  for  industrial  purposes. — 
Articles  enumerated  in  (a)  and  (b)  of  Section  301, 
and  otherwise  taxable,  are  exempt  if  used  for  an  indus- 
trial purpose.  Articles  sold  to  the  general  trade,  for 
sporting  purposes,  commercial  purposes,  or  other  pur- 
poses not  strictly  industrial,  are  not  exempt.  "Used 
for  industrial  purposes"  means  "used  in  connection 
with  or  in  the  promotion  of  some  industry."     (Art.  14.) 

Definition  of  "part." — "Parts"  of  taxable  articles  are 
also  taxable  under  Section  301.  A  part  so  taxable  is 
any  article  relatively  complete  within  itself  and  de- 
signed or  manufactured  for  the  special  purpose  of 
being  used  as  a  component  part  of  a  completed  muni- 
tion, and  which,  by  reason  of  some  peculiar  charac- 
teristic, loses  its  identity  as  a  commercial  commodity, 
and  which,  without  further  treatment,  cannot  be  used 
for  any  purpose  other  than  that  for  which  it  was 
designed. 

A  stock  or  commercial  commodity,  purchasable  in 
the  general  trade  or  in  the  open  market,  if  adapted 
for  use  in  the  manufacture  of  a  munition,  is  not  a 
"part"  within  the  meaning  of  Section  301,  and  will 
be  treated  as  raw  material,  provided  that  such  com- 
modities ordinarily  classed  as  commercial  are  "parts" 
within  the  meaning  of  the  law  if  manufactured  specially 
for  and  sold  to  a  manufacturer  to  be  by  him  incorpo- 
rated in  and  made  an  essential  part  of  any  munitions 
enumerated  in  section  301.     (Art.  13.) 

The  opinion  has  been  given  by  the  Commissioner  of 
Internal  Eevenue  that  the  mere  ordering  of  parts  from 
the  manufacturer  for  use  in  making  munitions  does  not 
constitute  those  parts  so  ordered  taxable,  unless  they 
are  ordered  specifically  for  and  manufactured  pursuant 
to  certain  specifications  given  by  the  munitions  manu- 
facturer. 


438  INCOME    AND    FEDERAL    TAX    REPORTS 

Repairs  not  taxable. — Manufacturers  who  make  repairs 
on  munitions  either  for  the  United  States  Government 
or  as  regular  commercial  work  will  not  be  subject  to 
the  munitions  tax,  provided  the  repairs  are  bona  fide 
repairs  and  do  not  involve  the  manufacture  and  sale 
of  a  completed  part  of  a  munition.  Expense  in  such 
repairs  for  labor,  material,  etc.,  must  be  eliminated  as 
a  deduction  in  the  return,  since  the  profit  is  not  con- 
sidered income  for  the  purpose  of  the  tax. 

Explosives. — Gunpowder  and  other  explosives  are  tax- 
able, excepting  blasting  powder  and  dynamite  used  for 
industrial    (not   commercial   or   sporting)    purposes. 

Cartridges. — Cartridges,  loaded  and  unloaded,  caps  or 
primers,  are  included,  except  those  used  for  industrial 
(not  commercial  or  sporting)  purposes. 

Projectiles. — Projectiles  include  any  and  all  missiles 
to  be  projected  from  a  gun,  cannon,  mortar  or  other 
firearm,  and  will  include  bullets,  balls,  shot  and  other 
missiles.     (Art.  2.)     All  projectiles  are  taxable. 

Shells  or  torpedoes. — Shells  or  torpedoes  include  any 
receptacle  and  charge  combined.  (Art.  2.)  All  are 
taxable. 

Firearms. — Firearms  of  any  kind  and  appendages, 
including  small  arms,  cannon,  machine  guns,  rifles, 
and  bayonets,  are  included,  with  no  exceptions  what- 
ever. 

Appendages. — Appendages  include  those  adjuncts  or 
accessories  appended  to  firearms  not  a  part  of  them, 
but  which  facilitate  their  use,  such  as  straps,  belts, 
scabbards,  shields,  holsters  or  other  appurtenances  com- 
mon to  such  firearms.     (Art.  2.) 

Profits  derived  from  original  manufacture  and  sale 
of  "appendages"  are,  of  course,  taxable. 

If  a  manufacturer  purchases  such  appendages  and 
sells  them  in  connection  with  a  firearm  which  he  him- 
self manufactures,  as  a  complete  unit,  e.  g.,  pistol  and 
holster,  the  entire  profit  he  makes  is  taxable.    If,  how- 


MUNITION    MANUFACTURER'S    TAX  439 

ever,  he  sells  the  purchased  appendage  as  a  separate 
unit,  not  in  connection  with  any  firearm,  he  is  consid- 
ered a  dealer,  and  the  profit  he  may  make  on  the  sale 
of  the  appendage  is  not  taxable. 

The  cost  of  purchased  appendages  or  other  equip- 
ment sold  with  the  completed  munition  is  a  proper 
deduction  in  ascertaining  net  profits. 

Appendages  only  partially  manufactured  will  be  con- 
sidered as  raw  material  to  the  manufacturer  who  pur- 
chases them;  the  cost  is  deductible  and  the  profits  made 
upon  completion  and  sale,  either  with  a  firearm  or 
separately  from  it,  are  taxable. 

Electric  motor  boats. — Electric  motor  boats  are  those 
boats,  regardless  of  size  or  character  of  construction, 
which  are  propelled  by  electric  power.  All  such  boats 
are  included  under  the  munitions  tax,  no  matter  for 
what  purpose  they  may  be  used. 

Submarines. — Submarine  or  submersible  vessels  in- 
clude all  craft,  no  matter  how  propelled,  manufac- 
tured for  the  purpose  of  being  at  will  submerged  be- 
neath the  surface  of  the  water.    All  are  taxable. 

Motors  and  generators  manufactured  specifically  for 
application  in  submarines  are  "parts"  within  the  mean- 
ing of  the  law,  and  the  profits  derived  by  the  manufac- 
turer upon  their  sale  and  disposition  are  taxable. 

Motors  and  generators  which  are  not  constructed  by 
the  manufacturer  specifically  for  and  according  to 
specifications  furnished  by  the  submarine  builder,  but 
are  merely  sold  by  him  from  stock  upon  receipt  of 
an  order  from  the  builder,  do  not  come  within  the 
definition  of  munitions  "parts,"  and  the  manufacturer 
in  such  a  case  is  not  liable  to  the  munitions  tax. 

Aeroplanes  are  not  "munitions." — Although  aeroplanes 
have  become  identified  with  the  machinery  by  means  of 
which  war  is  conducted,  almost  to  the  exclusion  of 
any  other  purpose,  they  are  not  included  as  munitions 
under  the   law,   and   are   therefore   not   taxable,    since 


440  INCOME   AND    FEDERAL    TAX   REPORTS 

the  tax  applies  only  to  profits  resulting  from  the  manu- 
facture and  sale  of  the  articles  specifically  mentioned. 

Ascertainment  of  net  or  taxable  income. — As  has  been 
made  clear  in  the  foregoing  pages,  the  tax  attaches 
only  to  net  income  derived  from  the  manufacture  and 
sale  of  the  articles  classed  as  munitions  and  enumer- 
ated and  described  hereinbefore.  In  order  to  ascertain 
the  income  which  is  so  taxable,  it  is  necessary  to  find 
the  gross  income  received  or  accrued  from  the  manu- 
facture and  sale  of  munitions,  and  to  subtract  from 
the  amount  of  this  gross  income  the  various  amounts 
which  are  allowed  as  deductions.  The  remainder  will 
be  the  net  taxable  income.  First  we  must  see  what 
is  comprised  in  the  term  "gross  income"  for  the  pur- 
poses of  the  Munitions  Tax  Law. 

Gross  income  denned. — The  gross  income  contemplated 
by  Title  III,  and  to  be  reported  in  the  return  for  the 
purpose  of  the  munitions  tax,  is  the  gross  amount  re- 
ceived by,  or  accrued  to  a  taxable  person  during  the 
calendar  year,  from  the  sale  or  disposition  of  articles 
named  in  section  301,  Title  III,  of  the  Act  of  Septem- 
ber 8,  1916,  with  the  exemptions  previously  noted  (ex- 
plosives, etc.,  used  for  industrial  purposes  and  con- 
tracts performed  prior  to  January  1,  1916). 

It  must  be  noted  with  regard  to  the  paragraph  in 
Art.  10,  Eeg.  39,  which  reads  as  follows:  "If,  how- 
ever, the  contracts  were  not  fully  performed  prior  to 
January  1,  1916,  any  profits  resulting  from  that  part 
of  the  contracts  performed  subsequent  to  January  1, 
1916,  must  be  returned  for  the  purpose  of  this  tax," 
that  while  this  seems  to  imply  that  only  receipts  from 
the  parts  of  such  contracts  fulfilled  subsequent  to  Jan- 
uary 1,  1916,  are  taxable,  and  that  deferred  payments 
received  for  such  portions  of  such  contracts  as  had 
been  completed  prior  to  January  1,  1916,  are  exempt, 
such  an  interpretation  is  not  intended,  and  it  is  now 
held   that   any   and   all   receipts   resulting   from   such 


MUNITION    MANUFACTURER'S    TAX  441 

partly  completed  contracts,  if  received  after  January 
1,  1916,  are  taxable.  The  paragraph  in  question 
wrongly  interpreted  the  clause  of  section  301,  which 
clause  provides  for  the  exemption  of  payments  re- 
ceived only  from  contracts  which  the  manufacturer  had 
fulfilled  in  toto,  for  his  part,  but  for  which  he  had  not 
yet  received  the  money  which  was  due  him. 

"In  so  far  as  the  paragraph  in  Article  II,  Regula- 
tions 39,  implies  that  any  profits  which  accrued  in  de- 
liveries made  in  1915  under  contracts  not  fully  per- 
formed prior  to  January  1,  1916,  and  which  profits 
were  received  subsequent  to  that  date,  should  not  be 
returned  as  taxable  income  when  received,  it  is  erro- 
neous,  and  is   hereby   annulled. 

"The  tax  being  imposed  upon  net  profits  received  or 
accrued,  the  revised  ruling  as  hereinbefore  set  out, 
contemplates  that  all  net  profits  received  subsequent 
to  January  1,  1916,  on  contracts  not  then  fully  per- 
formed must  be  returned  as  taxable  profits  of  the 
year  in  which  received,  regardless  of  when  they  may 
have  been  earned  or  accrued. 

"Hence  net  profits  received  subsequent  to  January 
1,  1916,  on  deliveries  made  under  contracts  which  were 
but  partially  performed  at  that  date,  constitute  taxable 
income  of  the  year  in  which  received,  and  cannot  law- 
fully be  excluded  therefrom."     (T.  D.  2458.) 

In  this  connection  also  it  must  be  remembered  that 
sales  the  receipts  from  which  are  to  be  counted  as  gross 
income  must  have  been  made  at  a  fair  market  price; 
that  is,  the  articles  must  not  have  been  sold  at  less 
than  the  market  price  for  the  benefit  of  an  individual 
or  for  any  other  purpose.  In  case  a  sale  has  been 
so  made  at  less  than  a  fair  market  price  the  amount 
of  the  proceeds  of  such  sale  for  the  purpose  of  the 
tax  will  be  considered  as  being  the  amount  that  would 
have  been  received  if  the  articles  had  been  sold  at  a 
fair  market  price. 


442  INCOME   AND    FEDERAL    TAX    REPORTS 

Deductions  allowed  from  gross  income. — In  order  to  as- 
certain the  net  income,  from  the  gross  income  as  above 
denned  the  following  deductions  will  be  made:  (a) 
cost  of  raw  materials ;  (b)  running  or  general  expenses ; 
(c)  part  cost  of  new  buildings,  machinery  and  equip- 
ment; (d)  interest;  (e)  taxes;  (f)  losses;  (g)  depreci- 
ation; (h)  amortization.  These  will  be  denned  in  the 
following  paragraphs,  it  being  borne  in  mind  that  each 
is  to  be  thought  of  as  included  under  the  title  of  this 
paragraph — deductions    allowed    from   gross   income. 

Cost  of  raw  materials. — It  will  be  remembered  that 
munitions  under  section  301  are  (a)  completed  articles 
and  (b)  parts,  which  have  been  denned  hereinbefore. 
Raw  materials,  used  in  the  manufacture  of  parts,  are 
held  to  be  any  crude  or  elemental  products  or  sub- 
stances necessary  to  the  manufacture  of  such  parts, 
and  which,  without  the  application  of  skill  or  science 
cannot  become  component  parts  or  elements  in  the 
finished  article  or  unit.  As  applied  to  the  manufac- 
ture of  a  completed  munition,  raw  materials  will  in- 
clude not  only  such  crude  products  and  elemental  sub- 
stances, but  all  essential  finished  or  unfinished  parts 
as  well.  The  cost  of  raw  material  authorized  as  a 
deduction,  is  the  cost  of  raw  materials  as  here  de- 
fined, which  materials  are  actually  used  in  the  manu- 
facture of  munitions.  Care  must  be  taken  to  exclude 
from  deduction  for  cost  of  raw  materials  the  cost  of 
such  raw  materials  as  are  used,  for  example,  in  an- 
other department  of  the  business,  which  is  not  de- 
voted to  the  making  of  munitions.  In  other  words,  the 
only  deduction  to  be  made  from  gross  income  on  ac- 
count of  the  cost  of  raw  materials  is  the  cost  of  such 
materials  as  are  actually  used  in  the  manufacture  of 
the  articles,  the  profit  on  the  sale  or  disposition  of 
which  is  subject  to  the  munition  manufacturer's  tax. 

It  is  not  permitted  to  charge  an  increase  over  the 
actual  manufacturing  or  purchase  cost  of  raw  materials 


MUNITION    MANUFACTURER'S    TAX  443 

because  of  the  fact  that  at  some  time  during  the  proc- 
ess of  manufacture  the  market  price  of  such  material 
was  such  that  it  could  have  been  disposed  of  at  a 
profit.  The  Department  holds  that  the  fact  that  the 
manufacturer  in  such  a  case  preferred  not  to  sell  the 
raw  materials,  but  to  continue  the  process  of  manufac- 
turing it  into  a  completed  munition,  in  the  hope  of 
receiving  the  equivalent  of  such  increased  price  in  the 
ultimate  selling  price  of  his  product,  is  evidence  that 
his  profit,  which  he  then  neglected  to  take,  is  reflected 
in  the  selling  price  of  the  completed  munition,  and 
that  no  deduction,  therefore,  is  allowable  except  for 
actual  cost,  whether  of  manufacture  or  of  purchase. 

The  foregoing  paragraph  is  of  particular  interest 
to  concerns  operating  several  plants,  as  fixing  the  basis 
of  price  at  which  the  munitions  plant  shall  purchase 
raw  material  from  another  plant  operated  by  the  same 
concern.  The  raw  material  must  be  sold  or  trans- 
ferred at  actual  cost. 

Running  or  general  expenses. — Running  or  general  ex- 
penses are  deductible,  to  the  extent  that  such  expenses 
are  incurred  and  paid  during  the  year  in  the  manu- 
facture of  articles  the  profits  from  the  sale  of  which 
are  included  in  the  gross  amount  of  income  returned. 

Such  expenses  will  include  expenditures  for  rent,  re- 
pairs and  maintenance,  heat,  light,  power,  insurance, 
management,  salaries  and  wages,  as  well  as  commissions 
and  bonuses  paid  for  the  securing  of  contracts. 

Where  another  business  is  carried  on  in  connection 
with  the  manufacture  of  munitions,  and  the  expenses 
of  munition  manufacture  cannot  be  segregated  from 
the  expenses  of  the  other  branches  of  the  business,  the 
expenses  deductible  are  "such  a  portion  of  the  entire 
expenses  as  the  gross  income  received  or  accrued  from 
the  manufacture  and  sale  or  disposition  of  war  muni- 
tions or  parts  thereof,  is  a  portion  of  the  entire  gross 
income  received  or  accrued  from  such  entire  manufac- 


444  INCOME   AND    FEDERAL    TAX    REPORTS 

turing  business."  For  example,  entire  expense  is  $600,- 
000;  gross  income  from  munitions  is  $300,000;  entire 
gross  income  is  $900,000.  In  such  a  case  the  deductible 
expense  would  be  one  third  of  $600,000.  This  is  held 
by  the  Department  to  be  a  more  accurate  method  of 
apportionment  of  expense  than  if  "net  profits"  were 
taken  as  a  basis. 

Since  income  received,  as  explained  above,  from 
contracts  completed  prior  to  January  1,  1916,  is  ex- 
empt, no  allowance  is  permitted  to  be  made  for  ex- 
penses incident  to  such  contracts. 

Commissions  and  bonuses  paid  for  securing  muni- 
tions contracts  are  an  allowable  deduction  under  "ex- 
penses" in  case  they  have  been  paid  for  securing  con- 
tracts the  receipts  from  which  are  subject  to  the  tax. 
Such  commissions  and  bonuses,  however,  should  be 
spread  over  the  life  of  the  contract  in  a  pro  rata  pro- 
portion and  deducted  from  the  gross  income  of  each 
year  until  the  contracts  are  fully  performed. 

Cost  of  buildings,  machinery  and  equipment. — The  cost 
of  new  buildings,  machinery  and  equipment  installed 
for  the  manufacture  of  munitions  will  be  charged  to 
capital  account  to  be  taken  care  of  through  the  depre- 
ciation or  amortization  accounts,  which  are  explained 
hereafter. 

Interest. — The  amount  deductible  from  gross  income 
on  account  of  interest  is  the  amount  of  interest  actually 
paid  during  the  year  on  debts  or  loans  contracted 
to  meet  the  needs  of  the  business  of  manufacturing 
munitions,  and  the  proceeds  of  which  were  actually 
used  for  that  purpose.  This  deduction  must  not  in- 
clude any  interest  paid  on  debts  or  loans  the  proceeds 
of  which  were  used  to  meet  the  needs  of  any  other 
business  in  which  the  manufacturer  may  have  been 
engaged.  This  deduction  can  be  taken  only  from  the 
gross  income  of  the  year  in  which  the  interest  was 
actually  paid. 


MUNITION    MANUFACTURER'S    TAX  445 

As  to  interest  paid  in  advance,  that  is  prior  to  1916, 
such  interest  is  not  deductible  if  the  money  upon 
which  the  interest  paid  was  used  in  the  furtherance  of 
contracts;  but  in  the  event  that  the  money  was  used 
in  the  construction  of  buildings  or  purchase  of  equip- 
ment, the  interest  paid  in  advance  for  the  use  of  such 
money  may  be  added  to  the  cost  of  buildings  and 
equipment.  In  such  a  case  the  interest  is  as  essen- 
tially a  part  of  the  cost  of  the  buildings  as  is  the 
principal  so  applied,  and  the  entire  amount,  principal 
and  interest,  is  subject  to  the  depreciation  and  amor- 
tization charges  explained  hereafter. 

Taxes. — The  taxes  deductible  are  those  taxes  of  all 
kinds  which  were  actually  paid  during  the  year  in 
which  the  gross  income  was  received  or  accrued  and 
which  were  imposed  with  respect  to  the  property  used 
in  the  manufacture  of  munitions. 

In  cases  where  other  businesses  are  conducted  in 
connection  with  the  making  of  munitions  and  the  taxes 
cannot  be  segregated,  the  apportionment  is  made  in 
the  same  manner  as  is  that  of  running  expenses  under 
similar  circumstances,  as  described  hereinbefore. 

The  War  Excess  Profits  tax  is  not  deductible  in  ascer- 
taining net  munition  income  for  the  purpose  of  measur- 
ing the  munitions  tax.  The  Treasury  Department  ruling 
on  this  point  is  as  follows : 

The  Munition  Manufacturer's  tax,  Title  III,  section  301,  of  the  Act  of 
September  8,  1916,  is  an  excise  tax  and  not  an  income  tax.  It  is  measured 
by  the  net  income  ascertained  as  provided  by  section  302,  Title  III,  Act  of 
September  8,  1916.  Paragraph  (d)  of  said  section  302  provides  for  de- 
duction from 

"Gross  income  received  or  accrued  from  the  sale  or  disposition"  of  the 
product  of  munitions  business 

"(d)  taxes  of  all  kinds  paid  during  the  taxable  year  with  respect  to  the 
business  or  property  relating  to  the  manufacture." 

The  net  income  by  which  the  War  Excess  Profits  tax  is  to  be  measured 
is  the  net  income  determined  for  income  tax  purposes,  but  without  the  de- 
duction of  income  or  excess  profits  tax  paid  within  the  year.  The  tax  upon 
this  income  is  in  addition  to  and  has  no  taxable  relation  to  any  other  tax. 

The  net  income  subject  to  income  tax  is  the  difference  between  gross 


446  INCOME   AND    FEDERAL    TAX    REPORTS 

income  as  defined  by  the  Income  Tax  law  and  the  several  deductions  pro- 
vided by  that  Act.  The  deductions  provided  must  not  include  "income  or 
excess  profits  tax."  Section  29,  Act  of  September  8,  1916,  as  amended  by 
the  Act  of  October  3,  1917,  permits  this  net  income,  for  the  purpose  of 
assessment  of  income  tax,  to  be  reduced  by  the  amount  of  war  excess  profits 
tax  assessed  for  the  same  calendar  or  fiscal  year. 

To  be  deductible  for  the  purpose  of  munitions  tax,  a  tax  must  have  been 
paid  within  the  taxable  year  "with  respect  to,"  that  is,  concerning  or  be- 
cause of  the  business  of  munitions  manufacture,  or  to  have  been  paid  on 
"property  relating  to  the  manufacture,"  that  is,  a  tax  on  property  having 
a  special  reference  to  the  manufacture  of  munitions. 

The  War  Excess  Profits  tax  is  not  levied  in  respect  of  any  business  or 
on  any  property  used  in  or  relating  to  manufacture,  but  (in  the  language 
of  section  201,  Act  of  October  3,  1917)  is  "in  addition  to  the  taxes  under 
existing  law  and  under  this  Act."  It  is  therefore  not  deductible  under 
paragraph  (d),  section  302,  Title  III,  Act  of  September  8,  1916,  in  ascer- 
taining net  income  from  munitions  manufacture  for  the  purpose  of  measur- 
ing the  excise  charge  on  the  business  of  munitions  manufacture. 

With  regard  to  the  capital  stock  tax  and  its  relation 
to  the  munitions  tax,  the  Act  provides  that  the  Capital 
Stock  Tax  returns  shall  be  made  in  July  and  Muni- 
tions Tax  returns  on  or  before  March  1,  upon  which 
basis  the  tax  is  paid.  It  therefore  follows  that  if  the 
munitions  tax  is  paid  prior  to  the  time  the  Capital 
Stock  Tax  return  is  prepared  and  filed  in  July,  the 
amount  of  the  munitions  tax  paid  in  1917  can  be  used 
as  a  credit  against  the  capital  stock  tax  to  be  paid 
for  the  fiscal  year  ending  June  30,  1918. 

As  to  whether  the  munitions  tax  paid  when  in  ex- 
cess of  the  capital  stock  tax  paid  can  be  used  as  a 
credit  in  subsequent  capital  stock  tax  returns  is  a 
question  that  has  not  yet  been  passed  on  by  the  De- 
partment, but  which  will  be,  in  case  it  becomes  perti- 
nent to  a  return. 

Losses. — The  losses  deductible  are  those  actually  sus- 
tained and  charged  off  during  the  year  for  which  the 
return  is  made,  and  which  were  sustained  on  account 
of,  or  in  connection  with,  the  business  of  the  manufac- 
ture and  sale  or  disposition  of  munitions  or  parts 
thereof,  and  will  include  losses  from  fire,  flood,  storm, 
accident  or  other  casualty  not  compensated  by  insur- 


MUNITION    MANUFACTURER'S    TAX  447 

ance  or  otherwise.  The  casualty  losses  allowable  are 
those  only  which  relate  to  the  business  of  munitions 
manufacturing. 

Losses  sustained  in  connection  with  collateral  invest* 
ments  or  in  connection  with  any  other  business,  the 
profits  from  which  are  not  taxable,  cannot  be  deducted 
from  the  gross  income  as  contemplated  by  the  Act. 

A  manufacturer  engaged  in  the  business  of  making 
munitions,  and  also  of  supplying  raw  materials  to 
other  munition  manufacturers,  may  not  deduct  losses 
incurred  in  the  latter  unless  such  materials  are  classed 
as  munitions  under  the  definitions  set  forth  herein- 
before, and  as  such  are  taxable. 

Depreciation. — Depreciation  is  a  lowering  in  value  or 
worth,  due  to  age,  use  or  other  causes.  The  deduction 
authorized  on  account  of  depreciation  relates  to  the 
loss  due  to  use,  wear  and  tear  of  physical  property, 
owned  and  used  by  a  manufacturer,  but  which  is  not 
specifically  designed  or  installed  for  the  purpose  of 
manufacturing  munitions  or  parts  thereof,  and  which, 
without  material  alteration  and  change,  may  be  used 
in  connection  with  any  other  business  in  which  the  per- 
son is  or  may  be  thereafter  engaged. 

The  annual  deduction  on  this  account  will  be  a  rea- 
sonable allowance  determined  upon  the  basis  of  the 
cost  and  probable  number  of  years  constituting  the  life 
of  the  property. 

Where  the  same  building,  machinery  or  other  prop- 
erty is  used  also  for  other  purposes  than  the  manu- 
facture of  munitions,  the  amount  deductible  from  gross 
income  on  account  of  depreciation  will  be  apportioned 
in  accordance  with  the  rule  for  apportionment  of  run- 
ning expenses,  as  set  forth  hereinbefore. 

Amortization. — A  special  amortization  deduction  is 
allowable  in  the  case  of  buildings  and  machinery  consti- 
tuting plants  constructed  especially  for  the  manufac- 
ture of  munitions,  and  which  will  have  no  substantial 


448  INCOME   AND    FEDERAL    TAX    REPORTS 

value  to  the  manufacturer,  except  for  salvage,  when  the 
contracts  executed  or  to  be  executed  for  the  manufacture 
of  munitions  have  been  fully  performed.  This  allow- 
ance is  to  be  determined  either  (1)  by  estimating  the 
number  of  years  the  property  is  to  be  used  in  the 
manufacture  of  munitions,  and  dividing  the  cost  of 
the  property,  less  estimated  salvage  value,  by  this 
number;  the  quotient  thus  obtained  will  be  the  amount 
of  the  allowed  annual  deduction  until  the  cost  of  the 
property  has  been  extinguished;  or  (2)  the  amortiza- 
tion allowance  may  be  determined  on  a  basis  of  the 
quantity  of  munitions  manufactured  under  contracts  in 
connection  with  the  fulfillment  of  which  the  buildings, 
machinery,  or  equipment  were  specially  constructed  or 
installed. 

The  amortization  deduction  should  be  set  up  on  the 
books  as  soon  as  possible,  but  since  in  practically  all 
cases,  the  Department  holds,  it  cannot  be  definitely 
determined  until  the  end  of  the  year,  when  the  net 
profits  have  been  determined,  it  will  be  permissible,  in 
order  to  get  credit  in  the  return,  to  set  up  the  amor- 
tization charge  as  soon  as  it  is  ascertained,  in  any 
event  not  later  than  as  of  December  31st  of  the  year 
for  which  the  return  is  made. 

Amortization  is  to  be  distinguished  from  deprecia- 
tion, which  is  explained  in  the  preceding  section.  The 
amounts  of  all  the  foregoing  allowable  deductions,  then, 
when  subtracted  from  the  amount  of  the  gross  income, 
leave  as  a  remainder  the  amount  of  net  income,  or 
profits  upon  which  the  tax  is  payable,  at  the  rate  of 
12y2  per  cent  for  the  calendar  year  1916  and  of  10  per 
cent  for  the  calendar  year  1917.  Instructions  for  making 
the  return  are  to  be  found  in  the  following  sections: 

Return,  assessment  and  payment  of  tax. — Every  person 
liable  for  the  tax  is  required  to  make  a  return  of  an- 
nual net  profits  or  income  in  the  manner  and  form 
prescribed  in  Form  1089. 


MUNITION    MANUFACTURER'S    TAX  449 

This  return,  properly  subscribed  and  sworn  to  before 
an  officer  qualified  to  administer  an  oath,  and  stamped 
with  the  seal  of  such  officer,  if  he  is  required  to  have 
a  seal,  must  be  filed  with  the  Collector  of  Internal 
Revenue  of  the  District  in  which  such  person  has  his 
principal  office  or  place  of  business,  on  or  before  March 
1st  next  following  the  year  in  which  the  return  is 
made  or  in  which  the  net  profits  were  received  or 
accrued. 

If  the  business  is  carried  on  by  an  individual  the 
return  must  be  signed  and  sworn  to  by  him;  if  by  a 
partnership,  then  by  two  members  of  the  firm;  if  by 
a  corporation  or  association,  then  by  two  of  the  prin- 
cipal officers  of  such  organization. 

As  soon  as  practicable  after  the  filing  of  the  return, 
the  Commissioner  of  Internal  Eevenue  will  assess  the 
tax  and  notify  the  taxable  person  of  the  amount  of 
the  tax,  which  must  then  be  paid  to  the  Collector  with 
whom  the  return  was  filed,  on  or  before  30  days  from 
the  date  of  such  notice. 

If  return  is  not  made,  or  is  incorrect. — In  case  no  re- 
turn is  made,  or  if  it  is  desired  to  verify  the  informa- 
tion presented  in  a  return  which  has  been  made,  the 
Commissioner  of  Internal  Revenue  or  his  agent  is  au- 
thorized to  examine  the  books  of  the  person  subject 
to  the  tax  or  whom  the  Commissioner  may  believe  is 
subject  to  the  tax,  in  order  that  the  amount  of  taxable 
profits  may  be  determined  and  the  tax  assessed  and 
collected. 

Penalties. — The  penalty  for  delinquency  in  tax  pay- 
ment, if  return  has  been  made  and  tax  assessed,  is  5 
per  cent  of  the  amount  of  the  tax  and  interest  at  the 
rate  of  1  per  cent  a  month  from  time  tax  became  due 
until  it  is  paid. 

Failure  to  make  return  as  required  subjects  the  de- 
linquent to  a  fine  of  not  more  than  $10,000  or  impris- 
onment not   exceeding  one  year,  or  both,  and  to   an 


450  INCOME   AND    FEDERAL    TAX    REPORTS 

assessment  of  50  per  cent  additional  tax.  It  is  pro- 
vided, however,  that  in  case  of  sickness  or  absence 
of  persons  required  to  make  or  verify  the  return,  the 
collector  may  upon  application  grant  an  extension  of 
not  exceeding  30  days  from  March  1st,  also  that  if  the 
return  is  not  made  within  the  required  time,  but  is 
afterward  filed  voluntarily  and  without  notice  from 
the  Collector,  and  it  is  shown  that  the  failure  to  file  the 
return  within  the  time  was  due  to  a  reasonable  cause 
and  not  to  wilful  neglect,  the  50  per  cent  addition  may 
not  be  made  to  the  tax. 


CHAPTER  XIX 

MUNITION  MANUFACTURER'S 
TAX   LAW 

BEING  TITLE  III  OF   "AN  ACT  TO   INCREASE   THE 
REVENUE  AND  FOR  OTHER  PURPOSES,"  AP- 
PROVED SEPTEMBER  8,  1916  (PUBLIC  NO. 
271.  64th  CONGRESS).    IN  EFFECT 
SEPTEMBER  9,  1916 


TITLE    III.— MUNITION    MANUFACTURER'S    TAX. 

Definitions. — Sec.  300  [of  the  general  revenue  Act  of 
which  this  Title  is  a  part].  That  when  used  in  this 
title — 

The  term  "person"  includes  partnerships,  corpora- 
tions, and  associations; 

The  term  "taxable  year"  means  the  twelve  months 
ending  December  thirty-first.  The  first  taxable  year 
shall  be  the  twelve  months  ending  December  thirty-first, 
nineteen  hundred  and  sixteen;  and 

The  term  "United  States"  means  only  the  States, 
the  Territories  of  Alaska  and  Hawaii,  and  the  District 
of  Columbia. 

Articles  subject  to  tax  and  rate  of  tax  (see  pp.  436- 
439). — Sec.  301.    (1)   That  every  person  manufacturing 

(a)  gun-powder  and  other  explosives,  excepting  blast- 
ing powder  and  dynamite  used  for  industrial  purposes; 

(b)  cartridges,  loaded  and  unloaded,  caps  or  primers, 
exclusive  of  those  used  for  industrial  purposes;  (c) 
projectiles,  shells,  or  torpedoes  of  any  kind,  including 

451 


452  INCOME    AND    FEDERAL    TAX    REPORTS 

shrapnel,  loaded  or  unloaded,  or  fuses,  or  complete 
rounds  of  ammunition-  (d)  firearms  of  any  kind  and 
appendages,  including  small  arms,  cannon,  machine 
guns,  rifles,  and  bayonets;  (e)  electric  motor  boats,  sub- 
marine or  submersible  vessels  or  boats;  or  (/)  any  part 
of  any  of  the  articles  mentioned  in  (b),  (c),  (d),  or 
(e) ;  shall  pay  for  each  taxable  year,  in  addition  to  the 
income  tax  imposed  by  Title  I,  an  excise  tax  of  twelve 
and  one-half  per  centum  upon  the  entire  net  profits  ac- 
tually received  or  accrued  for  said  year  from  the  sale 
or  disposition  of  such  article  manufactured  within  the 
United  States:  Provided,  however,  That  no  person 
shall  pay  such  tax  upon  net  profits  received  during  the 
year  nineteen  hundred  and  sixteen  derived  from  the  sale 
and  delivery  of  the  articles  enumerated  in  this  section 
under  contracts  executed  and  fully  performed  by  such 
person  prior  to  January  first,  nineteen  hundred  and 
sixteen. 

Termination  of  tax  after  war  (see  page  457,  post). — 
(2)  This  section  shall  cease  to  be  of  effect  at  the  end  of 
one  year  after  the  termination  of  the  present  European 
war,  which  shall  be  evidenced  by  the  proclamation  of 
the  President  of  the  United  States  declaring  such  war 
to  have  ended. 

Allowable  deductions. — Sec.  302.  That  in  computing 
net  profits  under  the  provisions  of  this  title,  for  the 
purpose  of  the  tax  there  shall  be  allowed  as  deductions 
from  the  gross  amount  received  or  accrued  for  the  tax- 
able year  from  the  sale  or  disposition  of  such  articles 
manufactured  within  the  United  States,  the  following 
items : 

(a)  The  cost  of  raw  materials  entering  into  the 
manufacture ; 

(b)  Running  expenses,  including  rentals,  cost  of  re- 
pairs and  maintenance,  heat,  power,  insurance,  manage- 
ment, salaries,  and  wages; 

(c)  Interest  paid  within  the  taxable  year  on  debts 


MUNITION    MANUFACTURER'S    TAX   LAW  453 

or  loans  contracted  to  meet  the  needs  of  the  business, 
and  the  proceeds  of  which  have  been  actually  used  to 
meet  such  needs; 

(d)  Taxes  of  all  kinds  paid  during  the  taxable  year 
with  respect  to  the  business  or  property  relating  to  the 
manufacture ; 

(e)  Losses  actually  sustained  within  the  taxable 
year  in  connection  with  the  business  of  manufacturing 
such  articles,  including  losses  from  fire,  flood,  storm,  or 
other  casualty,  and  not  compensated  for  by  insurance 
or  otherwise;  and 

(/)  A  reasonable  allowance  according  to  the  condi- 
tions peculiar  to  each  concern,  for  amortization  of  the 
values  of  buildings  and  machinery,  account  being  taken 
of  the  exceptional  depreciation  of  special  plants. 

Effect  of  selling  articles  at  less  than  fair  market  price. 
— Sec.  303.  If  any  person  manufactures  any  article 
specified  in  section  three  hundred  and  one,  during  any 
taxable  year  or  part  thereof,  whether  under  any  agree- 
ment, arrangement,  or  understanding,  or  otherwise,  sells 
or  disposes  of  any  such  article  at  less  than  the  fair  mar- 
ket price  obtainable  therefor,  either  (a)  in  such  manner 
as  directly  or  indirectly  to  benefit  such  person  or  any 
person  directly  or  indirectly  interested  in  the  business 
of  such  person,  or  (b)  with  intent  to  cause  such  benefit, 
the  gross  amount  received  or  accrued  for  such  year  or 
part  thereof  from  the  sale  or  disposition  of  such  article 
shall  be  taken  to  be  the  amount  which  would  have 
been  received  or  accrued  from  the  sale  or  disposition  of 
such  article  if  sold  at  the  fair  market  price. 

Making  and  filing  of  returns. — Sec.  304.  On  or  be- 
fore the  first  day  of  March,  nineteen  hundred  and  sev- 
enteen, and  the  first  day  of  March  in  each  year  there- 
after, a  true  and  accurate  return  under  oath  shall  be 
made  by  each  person  manufacturing  articles  specified  in 
section  three  hundred  and  one  to  the  collector  of  in- 
ternal revenue  for  the  district  in  which  such  person  has 


454  INCOME    AND    FEDERAL    TAX    REPORTS 

his  principal  office  or  place  of  business,  in  such  form  as 
the  Commissioner  of  Internal  Revenue,  with  the  ap- 
proval of  the  Secretary  of  the  Treasury,  shall  prescribe, 
setting  forth  specifically  the  gross  amount  of  income 
received  or  accrued  from  the  sale  or  disposition  of  the 
articles  specified  in  section  three  hundred  and  one,  and 
from  the  total  thereof  deducting  the  aggregate  items  of 
allowance  authorized  in  section  three  hundred  and  two, 
and  such  other  particulars  as  to  the  gross  receipts  and 
items  of  allowance  as  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  may  require. 

Payment  of  tax. — Sec.  305.  All  such  returns  shall 
be  transmitted  forthwith  by  the  collector  to  the  Com- 
missioner of  Internal  Revenue,  who  shall,  as  soon  as 
practicable,  assess  the  tax  found  due  and  notify  the 
person  making  such  return  of  the  amount  of  tax  for 
which  such  person  is  liable,  and  such  person  shall  pay 
the  tax  to  the  collector  on  or  before  thirty  days  from 
the  date  of  such  notice. 

Procedure  when  no  return  or  incorrect  return  is  filed. 
— Sec.  306.  If  the  Secretary  of  the  Treasury  or  the 
Commissioner  of  Internal  Revenue  shall  have  reason  to 
be  dissatisfied  with  the  return  as  made,  or  if  no  return 
is  made,  the  commissioner  is  authorized  to  make  an  in- 
vestigation and  to  determine  the  amount  of  net  profits 
and  may  assess  the  proper  tax  accordingly.  He  shall 
notify  the  person  making,  or  who  should  have  made, 
such  return  and  shall  proceed  to  collect  tax  in  the  same 
manner  as  provided  in  this  title,  unless  the  person  so 
notified  shall  file  a  written  request  for  a  hearing  with 
the  commissioner  within  thirty  days  after  the  date  of 
such  notice;  and  on  such  hearing  the  burden  of  estab- 
lishing to  the  satisfaction  of  the  commissioner  that  the 
gross  amount  received  or  accrued  or  the  amount  of  net 
profits,  as  determined  by  the  commissioner,  is  incorrect, 
shall  devolve  upon  such  person. 


MUNITION    MANUFACTURER'S    TAX    LAW  455 

Temporary  owners,  agents  and  others. — Sec.  307.  The 
tax  may  be  assessed  on  any  person  for  the  time  being 
owning  or  carrying  on  the  business,  or  on  any  person 
acting  as  agent  for  that  person  in  carrying  on  the  busi- 
ness, or  where  a  business  has  ceased,  on  the  person  who 
owned  or  carried  on  the  business,  or  acted  as  agent  in 
carrying  on  the  business  immediately  before  the  time  at 
which  the  business  ceased. 

Examination  of  books. — Sec.  308.  For  the  purpose  of 
carrying  out  the  provisions  of  this  title  the  Commis- 
sioner of  Internal  Revenue  is  authorized,  personally  or 
by  his  agent,  to  examine  the  books,  accounts,  and  rec- 
ords of  any  person  subject  to  this  tax. 

Disclosure  or  inspection  of  returns  prohibited.  —  Sec. 
309.  No  person  employed  by  the  United  States  shall 
communicate,  or  allow  to  be  communicated  to  any  per- 
son not  legally  entitled  thereto,  any  information  ob- 
tained under  provisions  of  this  title,  or  allow  any  such 
person  to  inspect  or  have  access  to  any  return  furnished 
under  the  provisions  of  this  title. 

Penalties  for  false  returns. — Sec.  310.  Whoever  vio- 
lates any  of  the  provisions  of  this  title  or  the  regula- 
tions made  thereunder,  or  who  knowingly  makes  false 
statements  in  any  return,  or  refuses  to  give  such  infor 
mation  as  may  be  called  for,  is  guilty  of  a  misdemeanor, 
and  upon  conviction  shall,  in  addition  to  paying  any  tax 
to  which  he  is  liable,  be  fined  not  more  than  $10,000,  or 
imprisoned  not  exceeding  one  year,  or  both,  in  the  dis- 
cretion of  the  court. 

Administrative  provisions. — Sec.  311.  All  administra- 
tive, special,  and  general  provisions  of  law,  relating  to 
the  assessment  and  collection  of  taxes  not  specifically 
repealed,  are  hereby  made  to  apply  to  this  title  so  far  as 
applicable  and  not  inconsistent  with  its  provisions. 

Regulations.  —  Sec.  312.  The  Commissioner  of  In- 
ternal Revenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  shall  make  all  necessary  regulations  for 


456  INCOME    AND    FEDERAL    TAX    REPORTS 

carrying  out  the  provisions  of  this  title,  and  may  re- 
quire any  person  subject  to  such  provisions  to  furnish 
him  with  further  information  whenever  in  his  judgment 
the  same  is  necessary  to  collect  the  tax  provided  for 
here. 

TITLE  IX. 

Invalidity  of  one  clause  not  to  affect  other  clauses. — 
Sec.  900.  That  if  any  clause,  sentence,  paragraph,  or 
part  of  this  Act  shall  for  any  reason  be  adjudged  by 
any  court  of  competent  jurisdiction  to  be  invalid,  such 
judgment  shall  not  affect,  impair,  or  invalidate  the  re- 
mainder of  said  Act,  but  shall  be  confined  in  its  opera- 
tion to  the  clause,  sentence,  paragraph,  or  part  thereof 
directly  involved  in  the  controversy  in  which  such  judg- 
ment shall  have  been  rendered. 

Effective  on  day  following  passage  of  Act. — Sec.  902. 
That  unless  otherwise  herein  specially  provided  this  Act 
shall  take  effect  on  the  day  following  its  passage,  and 
all  provisions  of  any  Act  or  Acts  inconsistent  with  the 
provisions  of  this  Act,  are  hereby  repealed. 

Approved  by  the  President,  September  8,  1916. 

AMENDMENT  TO  MUNITION  MANUFACTURER'S  TAX  LAW. 

Contained  in  Title  II  of  "An  Act  to  Provide  Revenue  to  De- 
fray War  Expenses,  and  for  Other  Purposes," 
Approved  October  3,  1917. 

(Public — No.  50 — 65th  Congress.) 
In  effect  October  4,  1917. 

Rate  of  tax  reduced.  —  Sec.  214  *  *  *  Subdivi- 
sion (1)  of  section  three  hundred  and  one  of  such  Act 
of  September  eight,  nineteen  hundred  and  sixteen,  i3 
hereby  amended  so  that  the  rate  of  tax  for  the  taxable 
year  nineteen  hundred  and  seventeen  shall  be  ten  per 
centum  instead  of  twelve  and  one-half  per  centum,  as 
therein  provided. 


MUNITION    MANUFACTURER'S    TAX   LAW  457 

Act  ineffective  after  January  1,  1918. — Subdivision  (2) 
of  such  section  is  hereby  amended  to  read  as  follows: 
"(2)  This  section  shall  cease  to  be  of  effect  on  and 
and  after  January  first,  nineteen  hundred  and  eigh- 
teen." 

Approved  by  the  President,  October  3,  1917. 


CHAPTER  XX 
SPECIAL  TAXES  ON  OCCUPATIONS 

History. — These  special  taxes  on  occupations  are  part 
of  the  miscellaneous  taxes  included  in  Title  IV  of  "An 
Act  to  Increase  the  Revenue  and  for  Other  Purposes," 
approved  on  September  8,  1916.  They  are  based  largely 
on  the  Acts  of  June  13,  1898,  and  October  22,  1914. 

In  general,  Title  IV  repeals  the  Emergency  Revenue 
Act  of  October  22,  1914,  except  the  sections  relating  to 
certain  occupations  and  to  tobacco  manufacturers.  The 
enforcement  of  these  sections  was  extended  to  January 
1,  1917.  Accordingly,  the  tax  on  the  old  basis  remained 
in  force  for  the  period  up  to  and  including  December 
31,  1916. 

The  present  tax,  which  is  an  annual  one,  became  ef- 
fective on  the  first  of  January,  1917.  Inasmuch  as  the 
taxable  year  extends  from  July  first  to  June  thirtieth  of 
the  year  following,  the  first  assessment  was  made  to  in- 
clude the  first  six  months  of  1917.  Thereafter  the  tax- 
able period  is  one  year,  extending  from  the  first  of 
July.  Accordingly,  the  tax  payment  made  on  July  1, 
1917,  gives  permission  to  do  business  up  to  July  1, 
1918. 

Who  pays  the  tax. — Every  person,  firm  or  corpora- 
tion doing  business  in  the  United  States  and  engaged 
in  any  of  the  nine  "occupations"  listed  below  is  sub- 
ject to  this  tax: 

(1)  Brokers — executing  purchases  and  sales  of  stocks 

and  bonds,  money,   commercial  paper,   etc. 

(2)  Pawnbrokers. 

(3)  Ship  brokers. 

458 


SPECIAL    TAXES    ON    OCCUPATIONS  459 

(4)  Custom-house  brokers. 

(5)  Proprietors   of   theaters,   museums    and    concert 

halls. 

(6)  Proprietors  of  circuses. 

(7)  Proprietors  or  agents  of  all  other  public  exhibi- 

tions or  shows. 

(8)  Proprietors  of  bowling  alleys  and  billiard  rooms. 

(9)  Tobacco  manufacturers. 

Brokers. — The  annual  tax  payable  by  brokers  is  $30. 
For  the  purpose  of  this  tax  a  broker  is  considered  to 
be  any  person,  partnership  or  corporation  whose  busi- 
ness it  is  to  execute  for  others  purchases  or  sales  of 
stocks,  bonds,  exchange,  bullion,  coined  money,  bank 
notes,  promissory  notes  or  other  securities. 

In  determining  liability  for  this  tax  it  is  important 
to  find  out  whether  or  not  orders  are  being  executed 
for  others.  There  is  no  liability  where  a  person  ne- 
gotiates purchases  or  sales  solely  for  himself.  Accord- 
ing to  the  terms  of  a  court  decision:  "It  is  only  when 
making  sales  and  purchases  is  his  business,  his  trade, 
his  profession,  his  means  of  getting  his  living  or  mak- 
ing his  fortune,  that  he  becomes  a  broker  within  the 
meaning  of  the  statute."  (Warren  v.  Shook,  91  U.  S., 
704.) 

The  following  cases,  chosen  from  the  Treasury  de- 
cisions based  upon  the  provisions  of  the  old  law,  illus- 
trate the  general  scope  of  this  section  of  the  present 
law.  Inasmuch  as  this  "special  tax  on  occupations" 
is  practically  identical  with  the  War  Revenue  Acts  of 
June  13,  1898,  and  Oct.  22,  1914,  it  is  assumed  that 
Treasury  Department  rulings  relating  to  the  latter  Act 
will  apply  in  the  administration  of  this  Act. 

Loan  and  mortgage  companies  are  not  liable  for 
loaning  money  on  notes  or  bonds  secured  by  a  mort- 
gage or  trust  deed  on  real  estate.  However,  if  they 
purchase  notes,  bonds  or  other  securities  they  become 
liable  as  brokers. 


460  INCOME   AND    FEDERAL    TAX    REPORTS 

A  mining  syndicate  or  other  association  issuing  cer- 
tificates of  stock  in  a  company  organized  by  it  is  not 
required  to  pay  a  special  tax  as  a  broker  as  a  result 
of  those  transactions.  However,  a  manager  or  other 
person  employed  to  sell  the  certificates  on  commission 
is  a  broker  and  is  required  to  pay  the  tax. 

Express  companies  engaged  in  the  business  of  buy- 
ing or  selling  foreign  money  or  bills  of  exchange  are 
subject  to  the  tax.  On  the  other  hand,  an  express  or 
railway  agent  doing  business  for  his  principals  only  is 
not  considered  a  broker  and  therefore  is  not  taxable. 

The  business  of  selling  land  on  commission,  taking 
applications  for  farm  loans  and  writing  insurance  is 
not  the  business  of  a  broker  and  therefore  the  tax  is 
not  imposed. 

Each  branch  office  of  a  broker  is  subject  to  the  tax. 
For  the  purpose  of  this  tax  a  branch  office  is  consid- 
ered to  be  one  where  the  employee  in  charge  not  only 
receives  and  transmits  orders  with  the  money  to  the 
main  office,  but  also  receives  from  the  main  office 
moneys  for  disbursement  to  customers,  or  keeps  ac- 
counts with  customers,  or  does  other  business  with  re- 
lation to  the  transactions  of  brokers  at  such  branch 
offices. 

A  case  in  point  to  illustrate  the  application  of  this 
regulation  will  serve  to  make  the  ruling  clear:  A  cor- 
poration, a  dealer  in  investment  securities,  selling  se- 
curities that  it  owns  itself,  has  branch  offices  under  the 
control  of  managers,  who  in  turn  employ  a  number  of 
agents  as  salesmen.  Both  the  managers  and  the  sales- 
men are  employed  under  a  contract  that  requires  them 
to  devote  their  whole  time  to  the  sale  of  the  securities 
of  the  house  in  question.  Class  A  of  these  branch 
offices  both  purchases  and  sells  securities  under  author- 
ity of  the  main  office.  Class  B  of  the  offices  confines 
itself  to  the  sale  of  securities.  Are  either  or  both  of 
these  classes  subject  to  the  brokers'  tax?     In  this  in- 


SPECIAL    TAXES    ON    OCCUPATIONS  461 

stance  the  Treasury  Department  decided  that  all 
branch  offices  in  both  classes  A  and  B  were  subject  to 
the  tax. 

Pawnbrokers. — The  annual  tax  payable  by  pawnbrok- 
ers is  $50.  According  to  the  provisions  of  this  Act, 
the  pawnbroker's  business  is  one  which  receives,  by 
way  of  pledge,  pawn  or  exchange,  any  goods,  wares, 
merchandise  or  any  kind  of  personal  property  as  se- 
curity for  the  repayment  of  money  loaned. 

Although  up  to  this  time  there  have  been  but  few 
Treasury  decisions  on  special  phases  of  this  new  law, 
there  are  available  those  applying  to  the  old  law  which 
is  similar  in  almost  every  respect.  It  is  safe  to  as- 
sume, therefore,  that  the  former  rulings  will  apply  with 
equal  force  to  this  law.  The  following  are  of  impor- 
tance : 

A  person  is  not  required  to  pay  a  special  tax  as  a 
pawnbroker  for  rare  or  occasional  acts  which  cannot  be 
regarded  as  his  business  or  occupation. 

The  tax  is  not  required  to  be  paid  for  making  loans 
when  the  chattels  are  not  taken  or  received  by  way  of 
pledge,  pawn  or  exchange. 

A  person  using  no  tickets  in  his  business,  but  mak- 
ing a  pretense  of  buying  articles  which  are  brought  to 
him,  which  he  holds  with  a  verbal  agreement,  that  the 
articles  can  be  bought  back  again  by  the  person  sell- 
ing them  upon  the  payment  of  a  specified  bonus,  is 
liable  to  the  tax  as  a  pawnbroker. 

Ship  brokers. — The  amount  of  annual  tax  payable  by 
ship  brokers  is  $20.  Under  this  classification  is  in- 
cluded every  person,  partnership  or  corporation  whose 
business  it  is  as  a  broker  to  negotiate  freights  and 
other  business  for  the  owners  of  vessels,  or  for  the 
shippers  or  consignors  or  the  consignees  of  freight 
carried  by  vessels.  These  provisions  of  the  law  are 
specific  and  require  no  further  discussion. 


462  INCOME   AND    FEDERAL    TAX    REPORTS 

Custom-house  brokers. — For  custom-house  brokers  the 
annual  tax  is  $10.  Agents  for  others,  whose  business 
it  is  to  arrange  entries  and  other  custom-house  papers, 
or  transact  at  any  port  of  entry,  business  relating  to 
imports  and  exports  of  goods,  wares  or  merchandise,  are 
considered  to  be  custom-house  brokers. 

If  the  complete  business  of  a  custom-house  broker  is 
transacted  by  or  through  offices  at  different  ports  in 
one  district,  a  separate  and  distinct  tax  of  $10  must  be 
paid  for  each  of  the  offices. 

A  tax  stamp  taken  out  by  a  person  in  his  own  name 
as  a  custom-house  broker  is  sufficient  to  cover  the  busi- 
ness done  by  him  in  his  own  name,  at  the  place  of  business 
stated  therein,  whether  the  business  is  done  by  him  on 
his  own  account  or  as  an  agent  for  other  persons. 

An  agent  for  others,  whose  business  it  is  to  enter  and 
clear  vessels  at  the  custom-house,  cannot  be  relieved 
from  payment  of  the  tax  on  custom-house  brokers,  even 
though  he  may  in  addition  have  paid  a  tax  as  ship 
broker. 

Proprietors  of  theaters,  museums  and  concert  halls. — The 
annual  tax  payable  by  proprietors  of  theaters,  museums 
and  concert  halls  is  graded  according  to  the  following 
scale,  based  upon  the  seating  capacity: 

A  seating  capacity  of  not  more  than  250. .  $25 

A  seating  capacity  of  more  than  250  and 
not  over  500  50 

A  seating  capacity  of  more  than  500  and 
not  over  800  75 

A  seating  capacity  of  more  than  800 100 

In  cities,  towns  or  villages  having  a  population  of 
5,000  or  less,  the  amount  of  tax  payable  by  proprietors 
will  be  in  each  case  one-half  of  the  amount  indicated  in 
the  above  summary. 

Every  edifice  used  for  the  purpose  of  dramatic,  oper- 
atic or  other  performances  for  which  a  charge  for  ad- 


SPECIAL    TAXES    ON    OCCUPATIONS  463 

mission  is  made  is  subject  to  the  tax.  Armories  or 
halls  used  only  occasionally  for  concerts  or  theatrical 
performances  are  not  required  to  pay  the  tax. 

Moving  picture  shows  are  taxable  as  theaters  on  the 
same  basis  as  that  above  mentioned. 

Airdomes  in  which  are  given  open-air  operatic  or 
dramatic  or  other  representations,  plays  or  moving  pic- 
ture shows,  are  taxable  according  to  the  seating  capac- 
ity, as  are  theaters,  museums,  etc.  An  exception  is 
made,  however,  in  those  cases  where  the  airdome  is 
operated  in  conjunction  with  a  theater  for  which  the 
tax  has  been  paid.  Provided  the  seating  capacity  of 
the  airdome  does  not  exceed  that  of  the  theater,  and 
that  performances  are  not  given  simultaneously  in  the 
airdome  and  in  the  theater,  only  one  tax  is  payable. 
The  tax  paid  for  the  theater  will  be  considered  to  cover 
also  the  performances  given  in  the  airdome. 

Where  the  proprietor  of  a  theater  operates  an  air- 
dome at  another  location,  he  may,  upon  closing  his 
theater,  transfer  to  the  airdome  the  tax  stamp  orig- 
inally issued  for  the  theater.  It  is  understood,  of 
course,  that  in  such  a  case  the  seating  capacity  of  the 
airdome  may  not  exceed  that  of  the  theater.  Similarly, 
the  tax  stamp  may  be  transferred  from  an  airdome  to 
a  theater  operated  by  the  same  proprietor. 

In  cases  where  the  tax  is  paid  for  a  theater  of  a  cer- 
tain capacity  and  subsequently  its  capacity  is  increased, 
the  tax  is  payable  at  the  highest  rate.  However,  re- 
demption of  the  former  tax  stamp  may  be  made  for  its 
unexpired  term. 

The  owners  or  agents  of  theatrical  troupes,  traveling 
around  the  country  and  giving  performances  in  halls  or 
auditoriums  for  which  the  tax  has  not  been  paid  by  the 
owners  or  lessees,  are  required  to  pay  the  special  tax 
on  occupations.  They  may  have  the  tax  stamps  trans- 
ferred from  place  to  place,  within  the  State  only,  upon 
application  to  the  Collector  of  Internal  Kevenue. 


464  INCOME   AND    FEDERAL    TAX    REPORTS 

Proprietors  of  circuses. — The  annual  tax  payable  by 
proprietors  of  circuses  is  $100.  This  tax  is  payable  in 
every  State  or  Territory  or  in  the  District  of  Colum- 
bia, in  which  an  exhibition  is  given.  When  a  circus  is 
exhibiting  in  any  State,  say  in  the  month  of  July,  the 
special  tax  of  $100  is  required  to  be  paid  for  the  year 
beginning  July  first.  If  in  the  following  month  the  cir- 
cus goes  into  another  State,  the  tax  at  the  rate  of  $100 
for  the  year  is  to  be  reckoned  from  the  first  of  August 
to  the  first  of  July  following,  and  a  separate  tax  stamp 
must  be  taken  out  for  that  State,  and  so  on. 

For  each  additional  attraction,  side  show  and  the  like, 
for  which  a  separate  charge  for  admission  is  made, 
there  is  a  special  tax  liability  at  the  rate  of  $10  per 
annum.  This  tax  is  payable  according  to  the  terms  of 
that  section  of  the  Act  taxing  "proprietors  or  agents 
of  all  other  public  exhibitions  or  shows." 

For  the  purposes  of  this  Act,  a  circus  is  understood 
to  be  an  exhibition  of  "feats  of  horsemanship,  or  acro- 
batic sports  or  theatrical  performances  not  otherwise 
provided  for"  in  the  other  eight  classes  of  "occupa- 
tions" mentioned  in  the  Act. 

Variety  shows,  whether  given  at  summer  resorts  or 
elsewhere,  which  include  "acrobatic  sports,"  come  within 
the  definition  of  a  circus.    They  are  taxable  accordingly. 

In  some  cases  there  is  a  fine  distinction  between  ex- 
hibitions classified  as  circuses,  taxable  at  the  rate  of 
$100  per  annum,  and  those  coming  under  the  classifica- 
tion of  "other  public  exhibitions  or  shows,"  taxable  at 
the  rate  of  $10  per  annum.  The  Treasury  Department 
has  given  a  ruling  to  the  effect  that  "a  show  under  can- 
vas exhibiting,  among  other  things,  acrobatic  and  ath- 
letic exercises,  but  not  feats  of  horsemanship  and  hav- 
ing no  menagerie,  is  not  subject  to  special  tax  as  a  cir- 
cus— if  the  acrobatic  exercises  are  so  few  and  simple 
as  to  make  it  unreasonable  to  hold  that  they  constitute 
the  show  a  circus."    It  is  a  show  coming  under  the  cap- 


SPECIAL    TAXES    ON    OCCUPATIONS  465 

tion  of  "all  other  public  exhibitions  or  shows,"  consid- 
ered in  the  following  section  of  this  chapter. 

Proprietors  or  agents  of  all  other  public  exhibitions  or 
shows. — The  amount  of  annual  tax  payable  for  exhibi- 
tions coming  under  this  classification  is  $10.  All  forms 
of  exhibitions,  etc.,  not  specially  provided  for  in  the 
preceding  sections  of  the  Act  are  taxable  under  the  pro- 
visions of  this  paragraph.  An  exception  is  made  of 
"Chautauquas,  lecture  lyceums,  agricultural  or  indus- 
trial fairs,  or  exhibitions  held  under  the  auspices  of  re- 
ligious or  charitable  associations."  These  are  not  tax- 
able. As  with  other  forms  of  exhibitions  and  shows, 
the  tax  is  payable  for  each  State  in  which  the  perform- 
ance or  show  is  given. 

In  a  case  brought  before  the  District  Court  of  the 
United  States  by  the  Redpath  Lyceum  Bureau,  the  claim 
of  tax  exemption  was  made.  The  Act  provides  that  the 
tax  shall  not  apply  to  "Chautauquas,  lecture  lyceums, 
agricultural  or  industrial  fairs  or  exhibitions  under  the 
auspices  of  religious  or  charitable  associations."  It  was 
on  the  strength  of  this  provision  that  the  Redpath  Com- 
pany claimed  tax  exemption. 

The  decision  of  the  court  was  to  the  effect  that  the 
company  was  not  a  lecture  lyceum  within  the  meaning 
of  the  Act,  that  the  entertainments  were  not  given  un- 
der the  auspices  of  churches  and  that  consequently  the 
company  would  be  required  to  pay  the  tax. 

For  wagon  shows,  dog  and  pony  shows,  and  other 
similar  exhibitions  that  do  not  come  under  the  heading 
of  circuses,  the  annual  tax  of  $10  is  payable. 

Traveling  carnival  companies,  if  charging  one  gen- 
eral admission  to  the  grounds,  are  required  to  pay  the 
tax  at  the  rate  of  $10  per  annum.  Also,  for  each  sepa- 
rate attraction  for  which  a  separate  admission  is 
charged,  an  additional  tax  at  the  rate  of  $10  per  annum 
is  required  to  be  paid. 

The  show  of  a  medicine  vender  is  taxable  under  this 


466  INCOME    AND    FEDERAL    TAX    REPORTS 

section  of  the  Act  at  the  rate  of  $10  per  annum.  Such 
a  show  will  generally  include  athletic,  humorous  and 
comic  performances,  and  also  an  exhibition  of  rope- 
walking  and  trapeze  performances,  the  object  of  which 
is  to  attract  a  crowd. 

Agricultural  associations  are  required  to  pay  a  spe- 
cial tax  at  the  rate  of  $10  for  exhibitions  which  include 
horse  racing. 

Exhibitions  and  shows  given  on  fair  grounds,  but  not 
under  management  of  the  fair  association,  are  taxable. 

Concert  gardens  where  no  admission  fee  is  charged, 
but  where  beer  and  other  drinks  are  sold,  and  shows  or 
stage  entertainments  are  given,  come  under  this  clas- 
sification and  are  taxable  accordingly. 

A  lecturer  using  a  stereopticon  to  illustrate  his  lec- 
ture, and  charging  an  admission  fee,  is  liable  to  the  spe- 
cial tax. 

Exemptions. — The  following  are  examples  of  shows 
and  entertainments  not  taxable,  according  to  former 
Treasury  Department  rulings: 

The  tax  is  not  required  to  be  paid  by  proprietors  of 
restaurants  or  cafes  for  employing  bands  of  music  or 
orchestras  during  meal  hours  for  the  benefit  of  their 
patrons.  The  provision  is  made,  however,  that  there 
shall  be  no  admission  charge  and  that  no  performance 
or  exhibition  shall  be  given  in  connection  therewith. 

Amateur  theatrical  exhibitions,  given  either  in  pri- 
vate houses  or  in  licensed  public  halls,  for  payment  of 
expenses  incurred  in  giving  the  show  and  not  for 
pecuniary  profit,  are  not  subject  to  the  tax. 

Amateur  clubs  or  local  organizations  giving  exhibi- 
tions, even  though  they  charge  an  admission  price,  are 
not  required  to  pay  the  tax  if  the  proceeds  are  not  for 
the  pecuniary  profit  of  the  clubs  or  associations  but  are 
devoted  to  some  charitable  object  and  the  payment  of 
expenses. 

The  tax  is  not  required  for  bands  of  music  playing 


SPECIAL    TAXES    ON    OCCUPATIONS  467 

in  saloons  to  which  no  price  of  admission  is  charged 
and  where  persons  visiting  such  places  are  not  under 
any  obligation  to  buy. 

Other  entertainments  not  taxable  are:  merry-go- 
rounds,  fortune  telling,  football,  baseball,  etc.,  bands  in 
city  parks,  university  exhibitions,  and  the  like. 

Proprietors  of  bowling  alleys  and  billiard  rooms. — Every 
building  or  place  where  bowls  are  thrown  or  where 
games  of  billiards  or  pool  are  played,  except  private 
houses,  is  regarded  as  a  bowling  alley  or  a  billiard 
room.   The  tax  is  $5  per  annum  for  each  alley  or  table. 

A  recent  opinion  of  the  Treasury  Department  is  to 
the  effect  that  the  tax  is  applicable  to  pool  or  billiard 
tables  and  bowling  alleys  in  clubs,  fraternity  houses, 
lodge  halls,  charitable  institutions,  Y.  M.  C.  A.  build- 
ings, hotels,  boarding-houses,  etc.  These  are  not  con- 
sidered as  coming  under  the  classification  of  "private 
homes,"  and  consequently  are  taxable. 

Concerning  pool  tables,  etc.,  maintained  for  the  use  of 
officers  and  employees  of  State  and  municipal  govern- 
ments, a  fine  point  of  distinction  arises.  In  the  event 
of  the  tax  falling  upon  the  individuals,  group  of  indi- 
viduals, association  or  the  like,  the  tax  is  payable.  How- 
ever, the  tax  is  not  applicable  if  the  assessment  would 
have  the  effect  of  levying  upon  the  public  treasury. 
The  latter  is  true  because  of  the  fact  that  the  Federal 
Government  does  not  have  the  right  to  tax  "the  sover- 
eign instrumentalities  of  a  State  government  necessary 
to  the  exercise  of  its  governmental  functions." 

Post  exchanges  operated  under  the  complete  control 
of  the  Secretary  of  the  Navy  as  governmental  agencies 
are  not  taxable. 

Tobacco  manufacturers. — Every  person,  firm  or  cor- 
poration engaged  in  the  manufacture  and  sale  of  tobacco 
is  subject  to  this  tax.  In  all  cases  the  tax  is  computed 
on  the  basis  of  the  annual  sales  during  the  preceding 
fiscal  year. 


468  INCOME   AND    FEDERAL    TAX    REPORTS 

Herewith  is  summarized  the  basis  of  the  annual  tax, 
based  upon  the  volume  of  business  transacted  during 
the  year  preceding: 

Manufacturers  of  tobacco: 

Annual  sales  not  exceeding  50,000  pounds $3 

Annual  sales  over  50,000  pounds  but  not  exceed- 
ing 100,000  pounds 6 

Annual  sales  over  100,000  pounds  but  not  exceed- 
ing 200,000  pounds   12 

Annual  sales  exceeding  200,000  pounds  are  tax- 
able at  the  rate  of  8  cents  for  each  1,000  pounds 
or  fraction  thereof. 
Manufacturers  of  cigars: 

Annual  sales  not  exceeding  50,000  cigars 2 

Annual  sales  over  50,000  cigars  but  not  exceed- 
ing 100,000  cigars  3 

Annual  sales  over  100,000  cigars  but  not  exceed- 
ing 200,000  cigars   6 

Annual  sales  over  200,000  cigars  but  not  exceed- 
ing 400,000  cigars   12 

Annual  sales  exceeding  400,000  cigars  are  taxable 
at  the  rate  of  5  cents  for  each  1,000  cigars  or 
fraction  of  1,000. 

Manufacturers  of  cigarettes: 
Annual  sales  of  cigarettes  and  "little  cigars,"  not 
weighing  more  than  three  pounds  per  1,000,  are 
taxable  at  the  rate  of  3  cents  for  each  10,000 
cigarettes  or  fraction  of  10,000. 
In   all   cases  where   a   person,   firm   or  corporation 
manufactures  more  than  one  of  these  classes  of  articles, 
the  tax  is  payable  on  each  class  on  the  basis  as  indi- 
cated above,  based  on  annual  sales. 

Each  manufacturer  is  required  to  pay  tax  at  the  ap- 
propriate rate  for  each  factory  operated  under  his  ex- 
clusive ownership  or  control. 
Where  more  than  one  factory  or  branch  is  operated 


SPECIAL    TAXES    ON    OCCUPATIONS  469 

by  the  same  manufacturer,  each  tax  should  be  paid  to 
the  collector  of  the  district  where  the  factory  or  place 
of  business  is  located.  The  tax  stamp  showing  tax  pay- 
ment should  be  posted  at  each  factory  or  place  of 
business. 

In  making  a  tax  return  the  manufacturer  should  file 
a  sworn  statement  covering  each  factory  or  branch, 
showing  total  sales  during  the  preceding  fiscal  year. 
This  return  should  state  the  factory  number,  district 
and  State,  as  to  the  factory  operated,  and  also  the  out- 
put of  the  factory. 

The  amount  of  the  tax  is  computed  in  all  cases  on 
the  basis  of  sales  made  during  the  preceding  fiscal  year. 
Total  sales  made  during  that  period  is  the  basis,  re- 
gardless of  whether  business  was  conducted  during  the 
whole  year  or  only  part  of  the  year. 

Dealers  or  manufacturers  who  were  not  engaged  in 
business  during  the  preceding  fiscal  year  must  pay  the 
tax  and  secure  the  stamps  before  commencing  business. 
The  amount  of  the  tax  will  be  based  on  the  dealer's  or 
manufacturer's  estimate  of  the  probable  amount  of  his 
business  during  the  year.  When  the  limit  of  sales  al- 
lowed by  the  tax  already  paid  is  reached,  the  law  re- 
quires that  additional  tax  be  paid.  At  all  times  the 
liability  to  tax  on  the  basis  of  sales  should  be  covered. 

Below  is  given  a  synopsis  of  Treasury  Decisions 
made  under  the  Act  of  June  13,  1898.  Although  these 
may  not  be  considered  to  be  binding  under  the  present 
Act,  they  will  without  doubt  be  given  weight  in  consid- 
ering similar  questions. 

A  manufacturer  of  tobacco  or  cigars  cannot  sell  at 
retail  at  the  place  of  manufacture. 

Manufacturers  cannot  pack  goods  of  another  factory 
with  goods  made  at  their  own  factory. 

A  farmer  or  grower  of  tobacco  has  the  right  to  sell 
tobacco  of  his  own  growth  and  raising  to  any  person 
and  in  any  quantity  that  may  be  desired,  provided  its 


470        INCOME    AND    FEDERAL    TAX    REPORTS 

condition  has  not  been  changed  in  any  manner;  this, 
however,  is  a  personal  privilege,  and  cannot  be  dele- 
gated by  him  to  another  person.  The  farmer  cannot 
employ  another  person  to  travel  from  place  to  place  to 
sell  and  deliver  tobacco  to  consumers.  He  has  not  the 
right  to  place  the  tobacco  in  the  hands  of  another  per- 
son, to  be  sold  for  him  to  consumers.  However,  he 
may  place  it  in  the  hands  of  a  qualified  dealer  in  leaf 
tobacco,  to  be  sold  on  commission  to  other  qualified 
dealers,  or  to  manufacturers  of  tobacco  or  cigars,  or 
to  persons  who  buy  leaf  tobacco  in  packages  for  export. 

A  tax  stamp  issued  to  one  person  cannot  be  trans- 
ferred to  or  made  use  of  by  another.  The  one  excep- 
tion to  the  rule  is  in  the  event  of  the  death  of  the  tax- 
payer. 

Filing  of  returns. — The  annual  tax  return  is  required 
to  be  filed  by  every  person,  firm,  company,  corporation 
or  association  subject  to  the  tax.  The  return  is  to  be 
made  under  oath  and  filed  with  the  Collector  of  Inter- 
nal Kevenue  of  the  district  in  which  the  business  it  sit- 
uated. Payment  of  the  tax  in  the  form  of  cash,  cer- 
tified check  or  money  order,  accompanied  by  the  re- 
turn, should  be  made  before  the  month  of  July  of  each 
succeeding  year. 

Newly  organized  businesses  should  file  the  report  and 
pay  the  tax  before  beginning  operations. 

Penalties. — The  law  provides  that  "every  person  who 
carries  on  any  business  or  occupation  for  which  special 
taxes  are  imposed  by  this  title,  without  having  paid  the 
special  tax  therein  provided,  shall,  besides  being  liable 
to  the  payment  of  such  special  tax,  plus  a  penalty  of 
50  per  cent,  be  deemed  guilty  of  a  misdemeanor,  and 
upon  conviction  thereof  shall  pay  a  fine  of  not  more 
than  $500,  or  be  imprisoned  for  not  more  than  six 
months,  or  both,  in  the  discretion  of  the  court." 

Special  tax  stamps  are  required  to  be  posted  con- 
spicuously at  the  place  of  business. 


CHAPTER  XXI 
OCCUPATIONAL  TAXES  LAW 

BEING  TITLE   IV,  OF    "AN   ACT   TO   INCREASE   THE 
REVENUE  AND  FOR  OTHER  PURPOSES."  AP- 
PROVED SEPT.  8,  1916  (PUBLIC— No.  271— 
64th    CONGRESS)    IN    EFFECT 
SEPTEMBER  9,   1916 


TITLE  IV.— MISCELLANEOUS  TAXES 

Tax  on  brokers. — Sec.  407.  That  on  and  after  January 
first,  nineteen  hundred  and  seventeen,  special  taxes  shall 
be,  and  hereby  are,  imposed  annually,  as  follows,  that  is 
to  say: 

First.  [The  first  subdivision  related  to  bankers,  and 
went  out  of  effect  January  1,  1917.] 

Second.  Brokers  shall  pay  $30.  Every  person,  firm, 
or  company  whose  business  it  is  to  negotiate  purchaes 
or  sales  of  stocks,  bonds,  exchange,  bullion,  coined 
money,  bank  notes,  promissory  notes,  or  other  secur- 
ities, for  others,  shall  be  regarded  as  a  broker. 

Tax  on  Pawnbrokers. — Third.  Pawnbrokers  shall  pay 
$50.  Every  person,  firm,  or  company  whose  business  or 
occupation  it  is  to  take  or  receive,  by  way  of  pledge, 
pawn,  or  exchange,  any  goods,  wares,  or  merchandise, 
or  any  kind  of  personal  property  whatever,  as  security 
for  the  repayment  of  money  loaned  thereon,  shall  be 
deemed  a  pawnbroker. 

Tax  on  ship  brokers. — Fourth.  Ship  brokers  shall  pay 
$20.    Every  person,  firm,  or  company  whose  business  it 

471 


472  INCOME    AND    FEDERAL    TAX    REPORTS 

is  as  a  broker  to  negotiate  freights  and  other  business 
for  the  owners  of  vessels,  or  for  the  shippers  or  con- 
signors or  consignees  of  freight  carried  by  vessels,  shall 
be  regarded  as  a  ship  broker  under  this  section. 

Tax  on  customhouse  brokers.  —  Fifth.  Customhouse 
brokers  shall  pay  $10.  Every  person,  firm,  or  company 
whose  occupation  it  is,  as  the  agent  of  others,  to  arrange 
entries  and  other  customhouse  papers,  or  transact  busi- 
ness at  any  port  of  entry  relating  to  the  importation  or 
exportation  of  goods,  wares,  or  merchandise,  shall  be  re- 
garded as  a  customhouse  broker. 

Tax  on  proprietors  of  theaters,  etc. — Sixth.  Proprietors 
of  theaters,  museums,  and  concert  halls,  where  a  charge 
for  admission  is  made,  having  a  seating  capacity  of  not 
more  than  two  hundred  and  fifty,  shall  pay  $25 ;  having 
a  seating  capacity  of  more  than  two  hundred  and  fifty 
and  not  exceeding  five  hundred,  shall  pay  $50;  having 
a  seating  capacity  exceeding  five  hundred  and  not  ex- 
ceeding eight  hundred,  shall  pay  $75;  having  a  seating 
capacity  of  more  than  eight  hundred,  shall  pay  $100. 
Every  edifice  used  for  the  purpose  of  dramatic  or  oper- 
atic or  other  representations,  plays,  or  performances, 
for  admission  to  which  entrance  money  is  received,  not 
including  halls  or  armories  rented  or  used  occasionally 
for  concerts  or  theatrical  representations,  shall  be  re- 
garded as  a  theater:  Provided,  That  in  cities,  towns, 
or  villages  of  five  thousand  inhabitants  or  less  the 
amount  of  such  payment  shall  be  one-half  of  that  above 
stated.  Provided  further,  That  whenever  any  such  edi- 
fice is  under  lease  at  the  passage  of  this  Act,  the  tax 
shall  be  paid  by  the  lessee,  unless  otherwise  stipulated 
between  the  parties  to  said  lease. 

Tax  on  proprietors  of  circuses. — Seventh.  The  proprie- 
tor or  proprietors  of  circuses  shall  pay  $100.  Every 
building,  space,  tent,  or  area  where  feats  of  horseman- 
ship or  acrobatic  sports  or  theatrical  performances  not 
otherwise  provided  for  in  this  section  are  exhibited  shall 


OCCUPATIONAL    TAXES    LAW  473 

be  regarded  as  a  circus :  Provided,  That  no  special  tax 
paid  in  one  State,  Territory,  or  the  District  of  Columbia 
shall  exempt  exhibitions  from  the  tax  in  another  State, 
Territory,  or  the  District  of  Columbia,  and  but  one 
special  tax  shall  be  imposed  for  exhibitions  within  any 
one  State,  Territory,  or  District. 

Tax  on  proprietors  of  other  shows  for  money. — Eighth. 
Proprietors  or  agents  of  all  other  public  exhibitions  or 
shows  for  money  not  enumerated  in  this  section  shall 
pay  $10:  Provided,  That  a  special  tax  paid  in  one 
State,  Territory,  or  the  District  of  Columbia  shall  not 
exempt  exhibitions  from  the  tax  in  another  State,  Terri- 
tory, or  the  District  of  Columbia,  and  but  one  special 
tax  shall  be  required  for  exhibitions  within  any  one 
State,  Territory,  or  the  District  of  Columbia:  Provided 
further,  That  this  paragraph  shall  not  apply  to  Chau- 
tauquas,  lecture  lyceums,  agricultural  or  industrial  fairs, 
or  exhibitions  held  under  the  auspices  of  religious  or 
charitable  associations:  Provided  further,  That  an  ag- 
gregation of  entertainments,  known  as  a  street  fair, 
shall  not  pay  a  larger  tax  than  $100  in  any  State,  Terri- 
tory, or  in  the  District  of  Columbia. 

Tax  on  proprietors  of  bowling  alleys  and  billiard  rooms. 
— Ninth.  Proprietors  of  bowling  alleys  and  billiard 
rooms  shall  pay  $5  for  each  alley  or  table.  Every  build- 
ing or  place  where  bowls  are  thrown  or  where  games  of 
billiards  or  pool  are  played  except  in  private  homes 
shall  be  regarded  as  a  bowling  alley  or  a  billiard  room, 
respectively. 

Taxes  on  tobacco  manufacturers. — Sec.  408.  That  on 
and  after  January  first,  nineteen  hundred  and  seventeen, 
special  taxes  on  tobacco,  cigar  and  cigarette  manufac- 
turers shall  be,  and  hereby  are,  imposed  annually  as 
follows,  the  amount  of  such  annual  taxes  to  be  com- 
puted in  all  cases  on  the  basis  of  the  annual  sales  for 
the  preceding  fiscal  year : 


474  INCOME    AND    FEDERAL    TAX    REPORTS 

Manufacturers  of  tobacco  whose  annual  sales  do  not 
exceed  fifty  thousand  pounds  shall  each  pay  $3; 

Manufacturers  of  tobacco  whose  annual  sales  exceed 
fifty  thousand  and  do  not  exceed  one  hundred  thousand 
pounds  shall  each  pay  $6; 

Manufacturers  of  tobacco  whose  annual  sales  exceed 
one  hundred  thousand  and  do  not  exceed  two  hundred 
thousand  pounds  shall  each  pay  $12; 

Manufacturers  of  tobacco  whose  annual  sales  exceed 
two  hundred  thousand  pounds  shall  each  pay  at  the  rate 
of  8  cents  per  thousand  pounds,  or  fraction  thereof; 

Manufacturers  of  cigars  whose  annual  sales  do  not 
exceed  fifty  thousand  cigars  shall  each  pay  $2; 

Manufacturers  of  cigars  whose  annual  sales  exceed 
fifty  thousand  and  do  not  exceed  one  hundred  thousand 
cigars  shall  each  pay  $3; 

Manufacturers  of  cigars  whose  annual  sales  exceed 
one  hundred  thousand  and  do  not  exceed  two  hundred 
thousand  cigars  shall  each  pay  $6; 

Manufacturers  of  cigars  whose  annual  sales  exceed 
two  hundred  thousand  and  do  not  exceed  four  hundred 
thousand  cigars  shall  each  pay  $12 ; 

Manufacturers  of  cigars  whose  annual  sales  exceed 
four  hundred  thousand  cigars  shall  each  pay  at  the  rate 
of  5  cents  per  thousand  cigars,  or  fraction  thereof; 

Manufacturers  of  cigarettes,  including  small  cigars 
weighing  not  more  than  three  pounds  per  thousand, 
shall  each  pay  at  the  rate  of  3  cents  for  every  ten  thou- 
sand cigarettes,  or  fraction  thereof. 

In  arriving  at  the  amount  of  special  tax,  to  be  paid 
under  this  section  and  in  the  levy  and  collection  of  such 
tax,  each  person,  firm,  or  corporation  engaged  in  the 
manufacture  of  more  than  one  of  the  classes  of  articles 
specified  in  this  section  shall  be  considered  and  deemed 
a  manufacturer  of  each  class  separately. 

Penalties. — Every  person  who  carries  on  any  business 
or  occupation  for  which  special  taxes  are  imposed  by 


OCCUPATIONAL    TAXES    LAW  475 

this  title,  without  having  paid  the  special  tax  therein 
provided,  shall  besides  being  liable  to  the  payment  of 
such  special  tax,  be  deemed  guilty  of  a  misdemeanor, 
and  upon  conviction  thereof  shall  pay  a  fine  of  not  more 
than  $500,  or  be  imprisoned  not  more  than  six  months, 
or  both,  in  the  discretion  of  the  court. 

Administrative  provisions. — Sec.  409.  That  all  admin- 
istrative or  special  provisions  of  law,  including  the  law 
relating  to  the  assessment  of  taxes,  so  far  as  applicable, 
are  hereby  extended  to  and  made  a  part  of  this  title, 
and  every  person,  firm,  company,  corporation,  or  asso- 
ciation liable  to  any  tax  imposed  by  this  title,  shall  keep 
such  records  and  render,  under  oath,  such  statements 
and  returns,  and  shall  comply  with  such  regulations  as 
the  Commissioner  of  Internal  Revenue,  with  the  ap- 
proval of  the  Secretary  of  the  Treasury,  may  from  time 
to  time  prescribe. 

Act  of  October  22,  1914,  repealed  in  part. — Sec.  410. 
That  the  Act  approved  October  twenty-second,  nineteen 
hundred  and  fourteen,  entitled  "An  Act  to  increase  the 
internal  revenue,  and  for  other  purposes,"  and  the  joint 
resolution  approved  December  seventeenth,  nineteen 
hundred  and  fifteen,  entitled  "Joint  resolution  extending 
the  provisions  of  the  Act  entitled  'An  Act  to  increase 
the  internal  revenue,  and  for  other  purposes,'  approved 
October  twenty-second,  nineteen  hundred  and  fourteen, 
to  December  thirty-first,  nineteen  hundred  and  sixteen," 
are  hereby  repealed,  except  sections  three  and  four  of 
such  Act  as  so  extended,  which  sections  shall  remain  in 
force  till  January  first,  nineteen  hundred  and  seventeen, 
and  except  that  the  provisions  of  the  said  Act  shall  re- 
main in  force  for  the  assessment  and  collection  of  all 
special  taxes  imposed  by  sections  three  and  four  there- 
of, or  by  such  sections  as  extended  by  said  joint  reso- 
lution, for  any  year  or  part  thereof  ending  prior  to 
January  first,  nineteen  hundred  and  seventeen,  and  of 
all  other  taxes  imposed  by  such  Act,  or  by  such  Act  as 


476  INCOME    AND    FEDERAL    TAX    REPORTS 

so  extended,  accrued  prior  to  the  taking  effect  of  this 
title,  and  for  the  imposition  and  collection  of  all  pen- 
alties or  forfeitures  which  have  accrued  or  may  accrue 
in  relation  to  any  of  such  taxes. 

Approved  by  the  President,  September  8,  1916. 


CHAPTER  XXII 
WAR  EXCISE  TAXES 

Excise  taxes  on  sales. — War  excise  taxes  on  tobacco 
products,  beverages  and  certain  other  commodities  are 
imposed  by  the  Act  of  October  3,  1917,  the  date  of  their 
passage  being  construed  by  the  Treasury  Department 
as  meaning  October  4,  1917,  the  date  upon  which  the 
Act  became  effective.  Such  taxes  as  these  have  been  a 
favorite  means  of  obtaining  revenue  during  the  finan- 
cial stress  attendant  upon  the  several  war  crises  in  the 
history  of  the  United  States.  The  articles  upon  which 
they  have  been  imposed  have  been  usually  what  may, 
in  a  sense,  be  termed  "luxuries";  that  is,  not  indis- 
pensable, in  the  last  analysis,  yet  for  which  the  public 
would  be  willing  to  pay  a  price  which  included  the  tax 
rather  than  forego  them.  Such  taxes  were  first  levied 
by  the  Act  of  March  3,  1791.  Prior  to  the  Civil  War 
they  were  regarded  as  an  emergency  measure,  but  since 
then  excise  taxes  upon  tobacco  products  and  beverages 
have  become  a  regular  part  of  the  taxation  system  of 
the  country.  Naturally,  as  emergency  measures,  excise 
taxes  were  designed  primarily  for  the  purpose  of  obtain- 
ing revenue. 

The  Act  of  October  3,  1917,  levied  heavy  additional 
taxes  on  manufacturers  and  importers  of  tobacco  prod- 
ucts and  beverages,  and  also  extended  this  method  of 
taxation  to  a  number  of  articles  which  may  be  classed 
as  luxuries.  A  detailed  list  of  the  articles  will  be  found 
in  the  text  of  the  law.  A  summary,  with  the  amount 
of  the  tax  in  each  case,  is  as  follows: 

477 


478  INCOME   AND    FEDERAL    TAX    REPORTS 

Under  section  600 :  motor  vehicles,  mechanical  musical 
instruments,  including  records  for  player  pianos  and 
phonographs;  jewelry,  real  or  imitation;  cameras  and 
process  cameras;  sporting  goods,  such  as  tennis  rack- 
ets, golf  clubs,  baseball  bats,  baseballs,  footballs, 
billiard  and  pool  tables,  and  balls,  but  with  the  excep- 
tion of  children's  toys  and  games:  a  tax  at  the  time  of 
sale  amounting  to  3  per  cent  of  the  selling  price. 

Toilet  preparations;  proprietary  or  "patent"  medi- 
cines; chewing  gum:  2  per  cent  of  selling  price. 

Moving  picture  films,  not  exposed:  one-fourth  of  1 
cent  for  each  linear  foot;  exposed,  that  is,  ready  for 
projection  or  exhibition:  one-half  of  1  cent  per  linear 
foot.  These  taxes  are  imposed  when  the  film  is  first 
sold  or  leased,  and  are  payable,  like  other  excise  taxes, 
only  once. 

Under  section  603:  yachts  and  boats  of  the  kinds 
enumerated  below,  with  the  exception  of  those  used  ex- 
clusively in  trade  or  in  national  defence,  and  also  with 
the  exception  of  those  built  according  to  plans  and 
specifications  approved  by  the  Navy  Department: 

Yachts;  pleasure  boats;  power  boats;  motor  boats 
with  fixed  engines  and  sailing  boats  of  over  five  tons: 
length  not  over  fifty  feet,  fifty  cents  for  each  foot; 
length  over  fifty  feet  and  not  over  one  hundred  feet, 
$1  for  each  foot;  length  over  one  hundred  feet,  $2  for 
each  foot;  motor  boats  of  not  over  five  net  tons,  with 
fixed  engines,  $5.  The  length  which  is  to  govern  in  de- 
termining the  measurements  is  "over-all"  length. 

Floor  taxes. — Upon  the  foregoing,  with  the  exception 
of  moving-picture  films  and  boats,  a  floor  tax  is  imposed, 
designed  to  tax  the  stocks  of  these  commodities  in  the 
hands  of  wholesalers  or  jobbers  at  the  time  of  the  pas- 
sage of  the  Act.  This  floor  tax  is  an  amount  equiva- 
lent to  one-half  the  amount  of  the  tax  upon  the  sale  of 
the  respective  classes  of  articles,  that  is,  one-half  of  3 
per  cent  upon  the  one  class  and  one-half  of  2  per  cent 


WAti  EXCISE   TAXES  479 

upon  the  other,  based  on  the  price  paid  for  the  articles 
by  the  wholesaler  or  jobber  when  he  purchased  them. 
Those  liable  to  this  floor  tax  are  any  person  or  corpo- 
ration other  than  (1)  a  retailer  who  is  not  also  a  whole- 
saler or  (2)  the  manufacturer,  producer  or  importer. 

A  retailer  who  is  not  also  a  wholesaler  is  defined  as 
being  one  who  does  not  make  it  a  substantial  part  of 
his  business  to  sell  to  other  dealers,  and  who  does  not 
seek  or  solicit  such  business  for  profit,  although  he  may 
occasionally  sell  goods  to  other  retailers  at  less  than  the 
retail  price.  Dealers  in  automobiles  who  sell  both  to 
users  and  sub-agents  for  resale  are  wholesalers  and 
liable  to  floor  tax. 

Section  602,  which  imposes  this  floor  tax,  provides 
that  "nothing  in  this  section  shall  be  construed  to  im- 
pose a  tax  upon  articles  sold  and  delivered  prior  to 
May  9,  1917,  where  the  title  is  reserved  in  the  vendor  as 
security  for  the  payment  of  the  purchase  money." 

Shipments  in  transit  on  October  4,  1917,  charged  to 
a  jobber's  account,  but  shipped  direct  to  the  retailer, 
are  not  subject  to  the  floor  tax,  if  invoice  was  mailed  to 
the  consignee  prior  to  October  4,  in  which  case  the  goods 
belonged  to  the  consignee,  and  not  to  the  jobber. 

Goods  shipped  and  invoiced  prior  to  October  4,  if 
shipped  to  a  wholesaler,  are  liable  to  the  floor  tax.  If, 
however,  the  title  is  reserved  by  the  manufacturer  he  is 
subject  to  the  manufacturer's  sales  tax  and  the  whole- 
saler is  relieved  of  the  floor  tax. 

In  the  case  of  retail  and  wholesale  stocks  kept  by  the 
same  establishment,  the  retail  stock  is  not  subject  to 
the  floor  tax,  provided  that  the  retail  and  wholesale 
departments  are  kept  separate,  so  far  as  bookkeeping 
and  stockkeeping  are  concerned. 

The  floor  tax  returns  were  to  be  made,  as  provided 
in  section  1002,  within  thirty  days  of  the  passage  of 
the  Act.  The  date  of  payment,  but  not  that  of  the 
filing  of  the  return,  may  be  extended,  by  the  filing  of 


480  INCOME    AND    FEDERAL    TAX    REPORTS 

a  satisfactory  bond,  to  a  date  not  later  than  seven 
months  from  the  passage  of  the  Act.  For  form  of 
bond  for  the  extending  of  payment  of  certain  taxes, 
see  Form  723,  of  the  Treasury  Department. 

Liberty  bonds  or  certificates  of  deposit  on  purchase 
of  Liberty  bonds  are  acceptable  as  security  for  the 
payment  of  floor  taxes. 

Excise  tax  on  sales — by  whom  paid. — The  excise  tax 
on  sales  is  to  be  paid  by  the  manufacturer,  producer 
or  importer,  no  exception  being  made  in  the  case  of 
goods  exported. 

Where  a  contract  made  with  a  dealer,  for  sale  or 
lease,  prior  to  May  9,  1917,  precludes  the  adding  of  the 
whole  amount  of  tax  to  the  contract  price,  the  vendee 
or  lessee  must  pay  the  excess  to  the  vendor  at  the 
time  the  sale  or  lease  is  consummated,  but  the  actual 
payment  of  the  tax  must  be  made  by  the  vendor. 

The  term  "dealer"  includes  a  vendee  who  purchases 
an  article  with  intent  to  use  it  in  the  manufacture  or 
production  of  another  article   intended   for  sale. 

"Manufacturer"  is  construed  to  mean  the  latest 
manufacturer;  that  is,  the  one  who  completes  an  article 
ready  for  use  by  the  consumer.  Bottlers  of  drugs  or 
other  goods  received  in  bulk  are  held  to  be  manu- 
facturers. 

Where  a  manufacturer  consigns  his  entire  product 
to  a  retailer,  retaining  ownership  in  the  same  until  sold 
by  the  retailer,  he  must  make  monthly  returns,  and  to 
do  this  he  must  secure  returns  from  the  retailer  of  the 
goods  sold. 

Returns — excise  tax  on  sales. — Those  subject  to  the 
excise  tax  on  sales  must  make  returns  monthly  in 
duplicate,  on  or  before  the  close  of  the  month  follow- 
ing that  for  which  the  return  is  made,  and  pay  the 
tax  to  the  collector  of  internal  revenue  for  the  district 
in  which  is  located  the  principal  place  of  business. 

They  should  enter  on  the  return  the  net  quantity  of 


WAR  EXCISE  TAXES  481 

sales  during  the  month,  determined  by  deducting  from 
the  gross  quantity  of  sales  during  such  month,  trade 
discounts  and  any  quantity  sold  during  any  previous 
month  on  which  the  tax  was  paid  and  which  has  been 
returned  or  for  which  credit  has  been  allowed  for  any 
other  reason. 

Itinerant  manufacturers  must  report  sales  and  pay 
the  tax  in  the  district  in  which  the  sale  is  made. 

The  word  "sold"  is  construed  to  mean  that  a  con- 
tract of  sale  has  been  entered  into  between  vendor  and 
vendee  under  the  terms  of  which  the  article  which  is  the 
subject  of  the  contract  became  the  property  of  the  vendee. 

A  transfer  by  a  manufacturing  corporation  to  a  sell- 
ing corporation  is  a  sale,  and  in  such  a  case  the  price 
at  which  taxable  goods  shall  be  sold  to  the  selling  cor 
poration  must  not  be  less  than  that  charged  to  inde- 
pendent distributors  under  similar  conditions. 

Goods  delivered  subject  to  buyer's  approval  are  not 
to  be  reported  until  sale  is  completed. 

Motor  vehicles. — No  tax  under  this  Act  is  upon  the 
user  or  purchaser  of  motor  vehicles  but  only  upon  the 
manufacturer,  producer  or  importer.  There  are  no 
exemptions  for  cars  or  motor  trucks  used  for  business 
purposes;  all  are  taxable. 

Motor  vehicles  manufactured  abroad  by  companies 
completely  controlled  or  managed  in  the  United  States 
are  taxable.  There  is  no  drawback  on  exported  auto- 
mobiles. 

Automobiles  and  motorcycles  sold  to  the  United 
States  for  the  use  of  the  army,  including  those  sold 
by  the  manufacturer  to  the  United  States  Government 
on  contract  at  contract  prices,  are  taxable. 

A  chassis  is  held  to  be  an  automobile. 

An  automobile  body  is  not  taxable  when  sold  alone; 
when  sold  with  a  chassis  the  tax  rests  upon  the  com- 
pleted article.  A  motor  wheel  sold  alone  is  not  tax- 
able,   but    when    sold    in    connection    with    a    bicycle, 


482  INCOME    AND    FEDERAL    TAX    REPORTS 

velocipede  or  other  vehicle,  the  tax  attaches  to  the 
completed  article.  The  "Smith-Flyer,"  for  example,  a 
self-propelled  vehicle,  is  taxed  as  an  automobile. 

A  usable  automobile,  assembled  from  new  or  second- 
hand parts,  is  taxable,  but  used  or  second-hand  auto- 
mobiles are  not  taxable. 

Motorcycle  side  cars  are  not  taxable  unless  sold 
with  the  motorcycle,  in  which  case  the  tax  attaches  to 
the  completed  article. 

Where  a  chassis  is  sold  to  a  consumer  or  other 
person  or  concern  not  subject  to  the  tax,  the  sale  is 
taxable,  but  if  sale  is  made  to  one  who  is  subject  to 
tax,  the  tax  will  be  paid  by  the  manufacturer  of  the 
completed  machine. 

Attachments  or  accessories  are  taxable  if  sold  with 
the  machine,  otherwise  they  are  not  taxable. 

Mechanical  musical  instruments. — The  mechanical  mu- 
sical instruments  enumerated,  together  with  the  records 
used  in  connection  therewith,  are  taxable  at  the  3  per 
cent  rate.  It  is  held  that  accessories  for  player  pianos, 
phonographs,  etc.,  other  than  records,  are  not  taxable 
unless  sold  with  the  instrument,  in  which  case  the  tax 
attaches  to  the  price  for  which  the  instrument  and  its 
accessories  is  sold. 

Player  pianos  have  been  held  not  to  be  taxable.  The 
tax  on  piano  players  applies  to  the  player  device  if 
sold  as  a  separate  instrument  or  as  a  separate  feature. 
Where  a  player  is  sold  as  incorporated  in  a  piano,  the 
tax  is  upon  the  price  of  the  player  as  a  separate  device, 
if  such  price  can  be  separately  determined;  otherwise, 
the  tax  is  upon  the  entire  instrument,  including  piano.1 

Toy  talking  machines  or  phonographs  are  taxable. 

Dictaphones  and  dictagraphs,  used  for  commercial 
purposes,  are  not  taxable. 

iThe  recent  decision  (January  2,  1918)  holding  that  player  pianos  are 
not  taxable  except  when  sold  as  a  unit  with  player  device,  the  price  of 
which  can  not  be  segregated,  is  expected  to  save  the  piano  trade  $1,000,000  a 
year. 


WAR   EXCISE   TAXES  483 

Moving  picture  films. — The  amount  of  the  tax  on  mov- 
ing picture  films  is  given  above.  The  tax  is  not  on 
the  manufacture  of  the  film  itself,  but  only  upon  its 
sale  or  lease,  so  that  no  floor  tax  applies.  A  distributor 
of  films,  pure  and  simple,  is  not  subject  to  this  tax. 

A  laboratory  doing  the  mechanical  work  of  produc- 
ing a  positive  print,  and  charging  the  owner  for  labor 
and  materials,  and  having  itself  no  ownership  in  the 
films,  will  not  be  regarded  as  the  manufacturer  and  is 
not  liable  to  the  tax  if  it  does  not  sell  or  lease  the 
film.  Such  a  laboratory,  however,  should  keep  a  record 
of  such  films  for  the  information  of  revenue  officers. 
Blank  films  are  taxable  only  when  sold  by  a  manu- 
facturer or  importer.  Printed  or  hand-lettered  titles 
or  subtitles  used  in  connection  with  a  picture  are  held 
to  be  a  part  of  the  film  and  should  be  included  in  the 
length  of  the  film  when  tax  is  computed.  If  these 
projections  are  in  the  shape  of  slides  or  announce- 
ments, however,  no  tax  attaches. 

Returns  are  to  be  made  on  or  before  the  last  day 
of  each  month,  covering  the  sales  or  leases  made  dur- 
ing the  preceding  month.  For  films  not  exposed  the 
return  will  show  the  number  of  linear  feet  sold  dur- 
ing the  month;  for  films  containing  a  picture  ready 
for  projection  the  returns  will  show  the  number  of 
linear  feet  sold  or  leased  during  the  month.  The 
rates  of  tax  are  y±  and  V2  of  1  cent  per  foot  respec- 
tively, and  are  payable  only  once,  when  the  film  is 
first  sold  or  leased. 

Jewelry. — The  tax  on  jewelry,  3  per  cent  of  selling 
price,  is  to  be  computed  by  manufacturers  upon  the 
price  they  make  to  wholesalers  and  retailers,  less  trade 
discounts. 

As  to  what  is  classed  as  jewelry,  all  articles  so 
classed  .by  the  Board  of  Custom  Appraisers  are  in- 
cluded. 

All  precious   stones,  real  or  imitation,  whether  cut 


484  INCOME   AND    FEDERAL    TAX    REPORTS 

or  uncut,  which  are  set  and  ready  to  wear  in  condition 
sold  are  classifiable  as  jewelry  and  are  subject  to  the 
tax.  Precious  stones  cut  but  not  set  are  taxable  if 
sold  by  the  importer,  or  if  cutting  is  done  in  the 
United  States,  when  sold  by  the  manufacturer  or  dealer 
for  whom  the  cutting  was  done.  Matched  pearls  sold 
to  a  customer  are  taxable,  but  not  if  sold  to  dealers 
for  further  manufacture  or  completion.  This  applies 
also  to  loose,  drilled  pearls. 

All  watches  not  used  solely  for  utility  purposes  are 
classed  as  jewelry,  also  watches  worn  externally  for 
ornament,  and  all  other  watches  ornamented  with 
jewels,  or  other  ornamentation  than  engraving  or  en- 
gine turning. 

The  following  when  made  of  precious  or  imitation 
metals  to  be  carried  on  the  person  are  taxable  as 
jewelry : 

Dorean  (powder)  boxes;  vanity  boxes;  stamp  boxes; 
match  boxes;  cigarette  cases;  cigar  cases;  eyeglass 
cases;  eyeglass  chains;  eyeglass  holders;  lorgnettes; 
lorgnons;  card  cases;  vinaigrettes;  handkerchief  hold- 
ers; garters;  suspenders;  emblem  charms;  emblem 
pins ;  emblem  buttons ;  mesh  bags ;  memorandum  books ; 
lip  salve  cases;  eyebrow  pencils;  cigar  cutters;  com- 
passes; key  chains;  key  rings  and  other  like  articles. 

Other  articles  specifically  classed  as  jewelry  are: 
(a)  a  string  of  rose  beads,  {b)  pencil-  and  penholders 
manufactured  of  precious  or  imitation  precious  metals, 

(c)  souvenir  pins  for  use  and  sold  at  summer  resorts, 

(d)  knitting  needles,  protectors,  yarn  holders,  etc.,  if 
mounted  or  decorated  in  any  way  with  precious  or 
imitation  precious  metals,  (e)  slides  and  swivels  used 
in  connection  with  a  ribbon  chain,   (/)  lapel  flag  pins. 

It  is  held  that  the  following  shall  not  be  considered 
as  jewelry:  (a)  silver  tableware,  (b)  eyeglass  frames, 
(c)  plain  opera  and  field  glasses,  (d)  clocks,  (e)  foun- 
tain pens,   (/)   rosaries,   (g)  American  Red  Cross  but- 


WAR  EXCISE   TAXES  485 

tons,  (h)  metal  bag  frames  for  attachment  to  silk  bags, 
(t)  repairs  on  jewelry,  (j)  military  and  naval  insignia, 
(k)  plain  hair  combs  made  of  rubber,  shell,  or  cellu- 
loid, absolutely  unadorned. 

Sporting  goods,  etc. — The  tax  of  3  per  cent  is  im- 
posed only  upon  such  sporting  goods  as  are  specifically 
mentioned  in  the  Act. 

Bamboo  fishing  poles,  skee  ball  and  box-ball  alleys, 
flinch  and  rook  cards,  or  any  other  games  played  by 
both  adults  and  children  are  taxable. 

Wooden  racks  used  as  receptacles  for  poker  chips 
and  playing  cards,  toy  tennis  rackets,  tackle  and  other 
fishing  rod  appurtenances,  are  not  taxable. 

Toilet  articles  and  perfumes. — Toilet  articles,  such  as 
soaps  and  perfumes,  are  taxable  at  the  rate  of  2  per 
cent  of  the  price  for  which  they  are  sold  by  the  manu- 
facturer, producer  or  importer.  Among  such  taxable 
articles  are  shaving  soap,  toilet  soap,  Ivory  and  Pear's 
soaps,  petroleum  jellies  for  toilet  purposes,  and  chipped 
soap  in  barrels  or  kegs  for  export.  All  soaps  adver- 
tised or  held  out  to  be  suitable  for  soilet  purposes  or 
for  application  to  the  body  or  any  part  of  the  body 
as  a  cleansing  agent  are  included. 

All  hair  tonics  are  specifically  taxed. 

Raw  materials,  such  as  rose  oil,  etc.,  to  be  manu- 
factured into  perfumes,  etc.,  are  not  taxable.  Neither 
are  floor  oils,  floor  wax,  kitchen  soap  powders  and 
other  articles  used  exclusively  for  household  and  not 
for  toilet  purposes. 

Containers  of  perfumes,  etc.,  if  billed  and  shipped 
separately  are  not  taxable,  but  if  sold  together  with 
the  perfume  the  tax  attaches  upon  the  combined  price 
of  container  and  perfume. 

Medicinal  preparations,  etc. — The  taxability  of  a  medic- 
inal substance  or  preparation  is  determined  by  the 
way  it  is  prepared  or  marketed.     Where  taxable,  the 


486  INCOME    AND    FEDERAL    TAX    REPORTS 

rate  is  2  per  cent  of  the  selling  price.  Preparations 
intended  for  beasts  are  taxable  if  the  same  would  be 
taxable  when  used  by  man.  A  medicinal  preparation 
is  taxable  if  sold  under  any  trade  mark  or  trade  name; 
it  is  held  to  be  a  medicinal  preparation  if  recom- 
mended as  a  cure  or  remedy  for  any  sickness  or  dis- 
ease, and  is  taxable.  This  applies  even  if  recom- 
mended only  to  physicians,  as  it  is  a  recommendation 
intended  to  reach  the  public  through  the  physician. 
If,  however,  it  is  recommended  only  for  purposes 
other  than  medicinal,  as  for  its  food  value,  the  tax  does 
not  attach.     Insecticides,  for  example,  are  not  taxable. 

Licorice,  when  put  up  in  any  form  suitable  for 
medicinal  purposes  and  sold  under  a  trademark,  is 
taxable,  even  though  not  recommended  as  a  medicinal 
preparation. 

A  retail  dealer,  manufacturing  a  patent  medicine  by 
a  private  formula,  must  pay  the  tax,  even  though  he 
sells  the  product  only  in  his  retail  store.  Where 
medicinal  preparations  are  sold  under  labels  which  do 
not  indicate  that  the  formula  is  published,  they  will 
be  construed  to  be  prepared  under  secret  formulas, 
unless  an  affidavit  or  other  evidence  is  offered  to  show 
that  the  formula  is  not  a  secret. 

Chewing  gum. — On  all  chewing  gum  or  substitutes 
therefor  sold  by  manufacturer,  producer  or  importer, 
there  is  a  tax  of  2  per  cent  of  the  price  for  which  it 
is  sold. 

Cameras. — Cameras  are  taxable  at  the  rate  of  3  per 
cent.     Process  cameras  are  not  taxable. 

Returns. — The  returns  for  the  taxes  described  above 
are  to  be  made  in  duplicate  on  or  before  the  end  of 
each  month,  showing  the  net  sales  for  the  preceding 
month,  the  amount  of  which  is  ascertained  by  deduct- 
ing from  the  gross  sales  any  trade  discounts  or  other 
credits,  such  as  credits  for  goods  returned  which  had 
been  sold  in  a  previous  month  and  tax  thereon  paid. 


WAR   EXCISE   TAXES  487 

Penalties. — Penalty  for  failure  to  make  return  is  a 
fine  of  not  more  than  $1,000  or  imprisonment  for  not 
more  than  one  year,  or  both. 

Penalty  for  failure  to  pay  the  tax,  the  return  having 
been  duly  made,  is  5  per  cent  of  the  amount  of  the 
tax  plus  interest  at  1  per  cent  a  month  until  tax  is 
paid. 

Yachts,  etc. — The  tax  on  pleasure  boats,  with  the 
exception  of  those  exempt,  applies  to  all  boats  enu- 
merated in  section  603,  whether  in  use  or  commission 
or  not,  if  they  are  in  fit  condition  for  use.  The  tax  is 
payable  yearly  in  advance,  the  first  tax  period  begin- 
ning October,  1917,  and  ending  June  30,  1918.  The 
tax  will  be  paid  on  or  before  July  1  of  each  year 
following  for  succeeding  fiscal  years.  In  the  case 
of  the  purchase  of  a  new  boat  during  the  fiscal 
year,  the  tax  is  computed  by  multiplying  one-twelfth 
of  the  annual  tax  by  the  number  of  months,  including 
the  month  of  purchase,  remaining  prior  to  July  1 
following. 

Tax  returns  are  made  on  Form  732.  The  tax  re- 
ceipt (Form  725)  must  be  kept  on  board  when  the 
boat  is  in  use  and  shown  upon  demand  to  any  Internal 
Revenue  or  Navigation  officer. 

The  "user"  of  a  boat  is  held  to  mean  any  person 
who  purchases  a  vessel  for  his  own  use  as  distin- 
guished from  one  who  buys  as  a  dealer. 

Instructions  for  computing  tonnage  and  over-all 
length  will  be  found  on  Form  732. 

The  penalties  provided  for  failure  to  make  return 
and  pay  the  tax  are  a  fine  of  not  more  than  $1,000 
or  imprisonment  for  not  more  than  one  year,  or  both. 
If  the  return  has  been  made  but  payment  of  tax  de- 
layed, the  penalty  is  5  per  cent  of  the  amount  of  the 
tax  and  interest  at  1  per  cent  per  month. 


CHAPTER  XXIII 
WAR  EXCISE  TAXES  LAW 

BEING  TITLE  VI  OF  "AN  ACT  TO  PROVIDE  REVENUE 
TO  DEFRAY  WAR  EXPENSES,  AND  FOR  OTHER 
PURPOSES,"    APPROVED    OCTOBER    3,     1917. 
(PUBLIC— No.  50— 65th  CONGRESS.)    IN  EF- 
FECT   OCTOBER    4,     1917,    UNLESS 
OTHERWISE   SPECIALLY 
PROVIDED. 


TITLE   VI.— WAR   EXCISE    TAXES 

Tax  on  sale  or  lease  by  manufacturer,  producer,  or  im- 
porter.— Sec.  600  [of  the  general  revenue  Act  of  which 
this  Title  is  a  part].  That  there  shall  be  levied, 
assessed,  collected,  and  paid — 

Motor-driven  vehicles. — {a)  Upon  all  automobiles, 
automobile  trucks,  automobile  wagons,  and  motorcycles, 
sold  by  the  manufacturer,  producer,  or  importer,  a 
tax  equivalent  to  three  per  centum  of  the  price  for 
which  so  sold;  and 

Mechanical  musical  instruments  and  records. — (b)  Upon 
all  piano  players,  graphophones,  phonographs,  talking 
machines,  and  records  used  in  connection  with  any 
musical  instrument,  piano  player,  graphophone,  phono- 
graph, or  talking  machine,  sold  by  the  manufacturer, 
producer,  or  importer,  a  tax  equivalent  to  three  per 
centum  of  the  price  for  which  so  sold;  and 

Moving-picture  films. — (c)  Upon  all  moving-picture 
films  (which  have  not  been  exposed)  sold  by  the  manu- 

488 


WAR    EXCISE    TAXES    LAW  489 

facturer  or  importer,  a  tax  equivalent  to  one-fourth  of 
1  cent  per  linear  foot;  and 

(d)  Upon  all  positive  moving-picture  films  (contain- 
ing a  picture  ready  for  projection)  sold  or  leased  by 
the  manufacturer,  producer  or  importer,  a  tax  equiva- 
lent to  one-half  of  1  cent  per  linear  foot;  and 

Jewelry — real  or  imitation. — (e)  Upon  any  article  com- 
monly or  commercially  known  as  jewelry,  whether  real 
or  imitation,  sold  by  the  manufacturer,  producer,  or 
importer  thereof,  a  tax  equivalent  to  three  per  centum 
of  the  price  for  which  so  sold;  and 

Sporting  goods. — (/)  Upon  all  tennis  rackets,  golf 
clubs,  baseball  bats,  lacrosse  sticks,  balls  of  all  kinds, 
including  baseballs,  foot  balls,  tennis,  golf,  lacrosse, 
billiard  and  pool  balls,  fishing  rods  and  reels,  billiard 
and  pool  tables,  chess  and  checker  boards  and  pieces, 
dice,  games  and  parts  of  games,  except  playing  cards 
and  children's  toys  and  games,  sold  by  the  manufac- 
turer, producer,  or  importer,  a  tax  equivalent  to  three 
per  centum  of  the  price  for  which  so  sold;  and 

Toilet  preparations. — (g)  Upon  all  perfumes,  essences, 
extracts,  toilet  waters,  cosmetics,  petroleum  jellies,  hair 
oils,  pomades,  hair  dressings,  hair  restoratives,  hair  dyes, 
tooth  and  mouth  washes,  dentifrices,  tooth  pastes,  aro- 
matic cachous,  toilet  soaps  and  powders,  or  any  sim- 
ilar substance,  article,  or  preparation  by  whatsoever 
name  known  or  distinguished,  upon  all  of  the  above 
which  are  used  or  applied  or  intended  to  be  used  or 
applied  for  toilet  purposes,  and  which  are  sold  by  the 
manufacturer,  importer,  or  producer,  a  tax  equivalent 
to  two  per  centum  of  the  price  for  which  so  sold;  and 

Patent  Medicines. — (h)  Upon  all  pills,  tablets,  pow- 
ders, tinctures,  troches  or  lozenges,  sirups,  medicinal 
cordials  or  bitters,  anodynes,  tonics,  plasters,  liniments, 
salves,  ointments,  pastes,  drops,  waters  (except  those 
taxed  under  section  three  hundred  and  thirteen  of  this 
Act),  essences,  spirits,  oils,  and  all  medicinal  prepara- 


490  INCOME    AND    FEDERAL    TAX    REPORTS 

tions,  compounds,  or  compositions  whatsoever,  the 
manufacturer  or  producer  of  which  claims  to  have  any 
private  formula,  secret,  or  occult  art  for  making  or 
preparing  the  same,  or  has  or  claims  to  have  any  ex- 
clusive right  or  title  to  the  making  or  preparing  the 
same,  or  which  are  prepared,  uttered,  vended,  or  ex- 
posed for  sale  under  any  letters  patent,  or  trade-mark, 
or  which,  if  prepared  by  any  formula,  published  or  un- 
published, are  held  out  or  recommended  to  the  public  by 
the  makers,  venders,  or  proprietors  thereof  as  proprie- 
tary medicines  or  medicinal  proprietary  articles  or  prep- 
arations, or  as  remedies  or  specifics  for  any  disease,  dis- 
eases, or  affection  whatever  affecting  the  human  or 
animal  body,  and  which  are  sold  by  the  manufacturer, 
producer,  or  importer,  a  tax  equivalent  to  two  per  cen- 
tum of  the  price  for  which  so  sold;  and 

Chewing  gum. — (i)  Upon  all  chewing  gum  or  substi- 
tute therefor  sold  by  the  manufacturer,  producer,  or  im- 
porter, a  tax  equivalent  to  two  per  centum  of  the  price 
for  which  so  sold;  and 

Cameras. — (j)  Upon  all  cameras  sold  by  the  manufac- 
turer, producer,  or  importer,  a  tax  equivalent  to  three 
per  centum  of  the  price  for  which  so  sold. 

Monthly  returns. — Sec.  601.  That  each  manufacturer, 
producer,  or  importer  of  any  of  the  articles  enumerated 
in  section  six  hundred  shall  make  monthly  returns  un- 
der oath  in  duplicate  and  pay  the  taxes  imposed  on  such 
articles  by  this  title  to  the  collector  of  internal  revenue 
for  the  district  in  which  is  located  the  principal  place 
of  business.  Such  returns  shall  contain  such  informa- 
tion and  be  made  at  such  times  and  in  such  manner  as 
the  Commissioner  of  Internal  Eevenue,  with  the  ap- 
proval of  the  Secretary  of  the  Treasury,  may  by  regu- 
lations prescribe. 

Floor  tax  on  wholesaler's  stocks. — Sec.  602.  That  upon 
all  articles  enumerated  in  subdivisions  (a),  (b),  (e), 
(/)>  (ff)i  W>  (*)>  or  (i)  of  section  six  hundred,  which 


1*1 
• 


WAR    EXCISE    TAXES    LAW  491 

on  the  day  this  Act  is  passed  are  held  and  intended  for 
sale  by  any  person,  corporation,  partnership,  or  associa- 
tion, other  than  (1)  a  retailer  who  is  not  also  a  whole- 
saler, or  (2)  the  manufacturer,  producer,  or  importer 
thereof,  there  shall  be  levied,  assessed,  collected,  and 
paid,  a  tax  equivalent  to  one-half  the  tax  imposed  by 
each  such  subdivision  upon  the  sale  of  the  article  there- 
in enumerated.  This  tax  shall  be  paid  by  the  person, 
corporation,  partnership,  or  association  so  holding  such 
articles. 

Administration  of  floor  tax. — The  taxes  imposed  by  this 
section  shall  be  assessed,  collected,  and  paid  in  the  same 
manner  as  provided  in  section  ten  hundred  and  two 
in  the  case  of  additional  taxes  upon  articles  upon 
which  the  tax  imposed  by  existing  law  has  been  paid. 

Exemption. — Nothing  in  this  section  shall  be  construed 
to  impose  a  tax  upon  articles  sold  and  delivered  prior  to 
May  ninth,  nineteen  hundred  and  seventeen,  where  the 
title  is  reserved  in  the  vendor  as  security  for  the  pay- 
ment of  the  purchase  money. 

Yachts,  boats,  etc. — Sec.  603.  That  on  the  day  this  Act 
takes  effect,  and  thereafter  on  July  first  in  each  year, 
and  also  at  the  time  of  the  original  purchase  of  a  new 
boat  by  a  user,  if  on  any  other  date  than  July  first, 
there  shall  be  levied,  assessed,  collected,  and  paid,  upon 
the  use  of  yachts,  pleasure  boats,  power  boats,  and  sail- 
ing boats,  of  over  five  net  tons,  and  motor  boats  with 
fixed  engines,  not  used  exclusively  for  trade  or  national 
defense,  or  not  built  according  to  plans  and  specifica- 
tions approved  by  the  Navy  Department,  an  excise  tax 
to  be  based  on  each  yacht  or  boat,  at  rates  as  follows: 
Yachts,  pleasure  boats,  power  boats,  motor  boats  with 
fixed  engines,  and  sailing  boats,  of  over  five  net  tons, 
length  not  over  fifty  feet,  50  cents  for  each  foot,  length 
over  fifty  feet  and  not  over  one  hundred  feet,  $1  for  each 
foot,  length  over  one  hundred  feet,  $2  for  each  foot; 


4Q2  INCOME   AND    FEDERAL    TAX   REPORTS 

motor  boats  of  not  over  five  net  tons  with  fixed  en- 
gines, $5. 

Computation  of  tax. — In  determining  the  length  of  such 
yachts,  pleasure  boats,  power  boats,  motor  boats  with 
fixed  engines,  and  sailing  boats,  the  measurement  of 
over-all  length  shall  govern. 

In  the  case  of  a  tax  imposed  at  the  time  of  the  orig- 
inal purchase  of  a  new  boat  on  any  other  date  than 
July  first,  the  amount  to  be  paid  shall  be  the  same  num- 
ber of  twelfths  of  the  amount  of  the  tax  as  the  number 
of  calendar  months,  including  the  month  of  sale,  remain- 
ing prior  to  the  following  July  first. 

Approved  by  the  President,  October  3,  1917. 


CHAPTER  XXIV 
TAX  ON  BEVERAGES  LAW 

BEING   TITLE   IV  OF   "AN  ACT  TO   INCREASE    THE 
REVENUE   AND    FOR    OTHER    PURPOSES,"    AP- 
PROVED   SEPTEMBER    8,    1916.    (PUBLIC— 
No.  271— «4th  CONGRESS.)    IN  EFFECT 
SEPTEMBER  9,   1916. 


TITLE  IV.— MISCELLANEOUS  TAXES. 

Taxable  fermented  liquors — Basis  of  tax. — Sec.  400  [of 
the  general  revenue  Act  of  which  this  Title  is  a  part]. 
That  there  shall  be  levied,  collected,  and  paid  a  tax  of 
$1.50  on  all  beer,  lager  beer,  ale,  porter,  and  other  similar 
fermented  liquor,  brewed  or  manufactured  and  sold,  or 
stored  in  warehouse,  or  removed  for  consumption  or 
sale,  within  the  United  States,  by  whatever  name  such 
liquors  may  be  called,  for  every  barrel  containing  not 
more  than  thirty-one  gallons ;  and  at  a  like  rate  for  any 
other  quantity  or  for  the  fractional  parts  of  a  barrel 
authorized  and  defined  by  law.  And  section  thirty-three 
hundred  and  thirty-nine  of  the  Revised  Statutes  is  here- 
by amended  accordingly. 

Wine  defined. — Sec.  401.  That  natural  wine  within  the 
meaning  of  this  Act  shall  be  deemed  to  be  the  product 
made  from  the  normal  alcoholic  fermentation  of  the 
juice  of  sound,  ripe  grapes,  without  addition  or  abstrac- 
tion, except  such  as  may  occur  in  the  usual  cellar  treat- 
ment of  clarifying  and  aging :  Provided,  however,  That 
the  product  made  from  the  juice  of  sound,  ripe  grapes 

493 


494  INCOME    AND    FEDERAL    TAX    REPORTS 

by  complete  fermentation  of  the  must  under  proper  cel- 
lar treatment  and  corrected  by  the  addition  (under  the 
supervision  of  a  gauger  or  storekeeper-gauger  in  the  ca- 
pacity of  gauger)  of  a  solution  of  water  and  pure  cane, 
beet,  or  dextrose  sugar  (containing,  respectively,  not 
less  than  ninety-five  per  centum  of  actual  sugar,  calcu- 
lated on  a  dry  basis)  to  the  must  or  to  the  wine,  to  cor: 
rect  natural  deficiencies,  when  such  addition  shall  not 
increase  the  volume  of  the  resultant  product  more  thao 
thirty-five  per  centum,  and  the  resultant  product  does 
not  contain  less  than  five  parts  per  thousand  of  acid 
before  fermentation  and  not  more  than  thirteen  per 
centum  of  alcohol  after  complete  fermentation,  shall  be 
deemed  to  be  wine  within  the  meaning  of  this  Act,  and 
may  be  labeled,  transported,  and  sold  as  "wine,"  quali- 
fied by  the  name  of  the  locality  where  produced,  and 
may  be  further  qualified  by  the  name  of  its  own  particu- 
lar type  or  variety:  And  provided  further,  That  wine 
as  defined  in  this  section  may  be  sweetened  with  cane 
sugar  or  beet  sugar  or  pure  condensed  grape  must  and 
fortified  under  the  provisions  of  this  Act,  and  wines  so 
sweetened  or  fortified  shall  be  considered  sweet  wine 
within  the  meaning  of  this  Act. 

Rates  of  tax  and  methods  of  payment. — Sec.  402.  (a) 
That  upon  all  still  wines,  including  vermuth,  and  upon 
all  artificial  or  imitation  wines  or  compound  sold  as 
wine  hereafter  produced  in  or  imported  into  the  United 
States,  and  upon  ail  like  wines  which  on  the  date  this 
section  takes  effect  shall  be  in  the  possession  or  under 
the  control  of  the  producer,  holder,  dealer,  or  compoun- 
der there  shall  be  levied,  collected,  and  paid  taxes  at 
rates  as  follows: 

On  wines  containing  not  more  than  fourteen  per  cen- 
tum of  absolute  alcohol,  4  cents  per  wine  gallon,  the  per 
centum  of  alcohol  taxable  under  this  section  to  be  reck 
oned  by  volume  and  not  by  weight. 

On   wines   containing  more   than   fourteen   per  cen- 


TAX    ON    BEVERAGES    LAW  495 

turn  and  not  exceeding  twenty-one  per  centum  of  abso- 
lute alcohol,  10  cents  per  wine  gallon. 

On  wines  containing  more  than  twenty-one  per  cen- 
tum and  not  exceeding  twenty-four  per  centum  of  abso- 
lute alcohol,  25  cents  per  wine  gallon. 

All  such  wines  containing  more  than  twenty-four  per 
centum  of  absolute  alcohol  by  volume  shall  be  classed  as 
distilled  spirits  and  shall  pay  tax  accordingly :  Provided, 
That  on  all  unsold  still  wines  in  the  actual  possession  of 
the  producer  at  the  time  this  title  takes  effect,  upon 
which  the  tax  imposed  by  the  Act  approved  October 
twenty-second,  nineteen  hundred  and  fourteen,  entitled 
"An  Act  to  increase  the  internal  revenue  and  for  other 
purposes,"  and  the  joint  resolution  approved  December 
seventeenth,  nineteen  hundred  and  fifteen,  entitled 
"Joint  resolution  extending  the  provisions  of  the  Act 
entitled  'An  Act  to  increase  the  internal  revenue,  and 
for  other  purposes,'  approved  October  twenty-second, 
nineteen  hundred  and  fourteen,  to  December  thirty-first, 
nineteen  hundred  and  sixteen,"  has  been  assessed,  the 
tax  so  assessed  shall  be  abated,  or,  if  paid,  refunded  un- 
der such  regulations  as  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  th^ 
Treasury,  may  prescribe. 

(b)  That  the  taxes  imposed  by  this  section  shall  be 
paid  by  stamp  on  removal  of  the  wines  from  the  cus- 
tomhouse, winery,  or  other  bonded  place  of  storage  for 
consumption  or  sale,  and  every  person  hereafter  pro- 
ducing, or  having  in  his  possession  or  under  his  control 
when  this  section  takes  effect,  any  wines  subject  to  the 
tax  imposed  in  this  section  shall  file  such  notice,  de- 
scribing the  premises  on  which  such  wines  are  produced 
or  stored ;  shall  execute  a  bond  in  such  form ;  shall  make- 
such  inventories  under  oath;  and  shall,  prior  to  sale  or 
removal  for  consumption,  affix  to  each  cask  or  vessel 
containing  such  wine  such  marks,  labels,  or  stamps  as 
the  Commissioner  of  Internal  Revenue,  with  the  ap- 


496  INCOME   AND    FEDERAL    TAX   REPORTS 

proval  of  the  Secretary  of  the  Treasury,  may  from  time 
to  time  prescribe;  and  the  premises  described  in  such 
notice  shall,  for  the  purpose  of  this  section,  be  regarded 
as  bonded  premises.  But  the  provisions  of  this  sub- 
division of  this  section,  except  as  to  payment  of  tax  and 
the  affixing  of  the  required  stamps  or  labels,  shall  not 
apply  to  wines  held  by  retail  dealers,  as  denned  in  sec- 
tion thirty-two  hundred  and  forty-four  of  the  Eevised 
Statutes  of  the  United  States,  nor,  subject  to  regulations 
prescribed  by  the  Commissioner  of  Internal  Eevenue, 
with  the  approval  of  the  Secretary  of  the  Treasury, 
shall  the  tax  imposed  by  this  section  apply  to  wines  pro- 
duced for  the  family  use  of  the  producer  thereof  and 
not  sold  or  otherwise  removed  from  the  place  of  manu- 
facture and  not  exceeding  in  any  case  two  hundred  gal- 
lons per  year.  The  Commissioner  of  Internal  Revenue 
is  hereby  authorized  to  have  prepared  and  issue  such 
stamps  denoting  payment  of  the  tax  imposed  by  this  sec- 
tion as  he  may  deem  requisite  and  necessary;  and  until 
such  stamps  are  provided  the  taxes  imposed  by  this  sec- 
tion shall  be  assessed  and  collected  as  other  taxes  are 
assessed  and  collected,  and  all  provisions  of  law  relating 
to  assessment  and  collection  of  taxes,  so  far  as  ap- 
plicable, are  hereby  extended  to  the  taxes  imposed  by 
this  section. 

(c)  That  under  such  regulations  and  official  super- 
vision and  upon  the  giving  of  such  notices,  entries 
bonds,  and  other  security  as  the  Commissioner  of  In 
ternal  Revenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  may  prescribe,  any  producer  of  wines  de- 
fined under  the  provisions  of  this  section  or  section  four 
hundred  and  one  of  this  Act,  may  withdraw  from  any 
fruit  distillery  or  special  bonded  warehouse  grape 
brandy,  or  wine  spirits,  for  the  fortification  of  such 
wines  on  the  premises  where  actually  made:  Provided, 
That  there  shall  be  levied  and  assessed  against  the  pro- 
ducer of  such  wines  a  tax  of  10  cents  per  proof  gallon 


TAX    ON   BEVERAGES    LAW  497 

of  grape  brandy  or  wine  spirits  so  nsed  by  him  in  the 
fortification  of  such  wines  during  the  preceding  month, 
which  assessment  shall  be  paid  by  him  within  six  months 
from  the  date  of  notice  thereof :  Provided  further,  That 
nothing  herein  contained  shall  be  construed  as  exempt- 
ing any  wines,  cordials,  liqueurs,  or  similar  compounds 
from  the  payment  of  any  tax  provided  for  in  this  section. 

That  sections  forty-two,  forty-three,  and  forty-five  of 
the  Act  of  October  first,  eighteen  hundred  and  ninety,  as 
amended  by  section  sixty-eight  of  the  Act  of  August 
twenty-seventh,  eighteen  hundred  and  ninety-four,  are 
further  amended  to  read  as  follows: 

Amendment  relating  to  wine  spirits. — "Sec.  42.  That 
any  producer  of  pure  sweet  wines  may  use  in  the  prep- 
aration of  such  sweet  wines,  under  such  regulations  and 
after  the  filing  of  such  notices  and  bonds,  together  with 
the  keeping  of  such  records  and  the  rendition  of  such 
reports  as  to  materials  and  products  as  the  Commis- 
sioner of  Internal  Kevenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  may  prescribe,  wine  spirits 
produced  by  any  duly  authorized  distiller,  and  the  Com- 
missioner of  Internal  Eevenue,  in  determining  the  lia- 
bility of  any  distiller  of  wine  spirits  to  assessment  un- 
der section  thirty-three  hundred  and  nine  of  the  Eevised 
Statutes,  is  authorized  to  allow  such  distiller  credit  in 
his  computations  for  the  wine  spirits  withdrawn  to  be 
used  in  fortifying  sweet  wines  under  this  Act. 

Wine  spirits  denned  and  use  regulated. — "Sec.  43.  That 
the  wine  spirits  mentioned  in  section  forty-two  herein 
mentioned  is  the  product  resulting  from  the  distillation 
of  fermented  grape  juice,  to  which  water  may  have  been 
added  prior  to,  during,  or  after  fermentation,  for  the 
sole  purpose  of  facilitating  the  fermentation  and  eco- 
nomical distillation  thereof,  and  shall  be  held  to  include 
the  product  from  grapes  or  their  residues  commonly 
known  as  grape  brandy,  and  shall  include  commercial 
grape  brandy  which  may  have  been  colored  with  burnt 


498  INCOME   AND    FEDERAL    TAX    REPORTS 

sugar  or  caramel;  and  the  pure  sweet  wine  which  may 
be  fortified  with  wine  spirits  under  the  provisions  of 
this  Act  is  fermented  or  partially  fermented  grape 
juice  only,  with  the  usual  cellar  treatment,  and  shall 
contain  no  other  substance  whatever  introduced  before, 
at  the  time  of  or  after  fermentation,  except  as  herein 
expressly  provided:  Provided,  That  the  addition  of 
pure  boiled  or  condensed  grape  must  or  pure  crystal- 
lized cane  or  beet  sugar,  or  pure  dextrose  sugar  con- 
taining, respectively,  not  less  than  ninety-five  per 
centum  of  actual  sugar,  calculated  on  a  dry  basis,  or 
water,  or  any  or  all  of  them,  to  the  pure  grape  juice 
before  fermentation,  or  to  the  fermented  product  of 
such  grape  juice,  or  to  both,  prior  to  the  fortification 
herein  provided  for,  either  for  the  purpose  of  perfect- 
ing sweet  wines  according  to  commercial  standards  or 
for  mechanical  purposes,  shall  not  be  excluded  by  the 
definition  of  pure  sweet  wine  aforesaid:  Provided, 
however,  That  the  cane  or  beet  sugar,  or  pure  dextrose 
sugar  added  for  sweetening  purposes  shall  not  be  in 
excess  of  eieven  per  centum  of  the  weight  of  the  wine 
to  be  fortified:  And,  Provided  further,  That  the  addi- 
tion of  water  herein  authorized  shall  be  under  sucb 
regulations  as  the  Commissioner  of  Internal  Kevenue, 
with  the  approval  of  the  Secretary  of  the  Treasury, 
may  from  time  to  time  prescribe:  Provided,  however, 
That  records  kept  in  accordance  with  such  regulations 
as  to  the  percentage  of  saccharine,  acid,  alcoholic,  and 
added  water  content  of  the  wine  offered  for  fortifica- 
tion shall  be  open  to  inspection  by  any  official  of  the 
Department  of  Agriculture  thereto  duly  authorized  by 
the  Secretary  of  Agriculture;  but  in  no  case  shall  such 
wines  to  which  water  has  been  added  be  eligible  for 
fortification  under  the  provisions  of  this  Act,  where  the 
same,  after  fermentation  and  before  fortification,  have 
an  alcoholic  strength  of  less  than  five  per  centum  of 
their  volume. 


TAX    ON    BEVERAGES    LAW  499 

Withdrawal  of  wine  spirits  from  bond. — "Sec.  45.  That 
under  such  regulations  and  official  supervision,  and 
upon  the  execution  of  such  entries  and  the  giving  of 
such  bonds,  bills  of  lading,  and  other  security  as  the 
Commissioner  of  Internal  Eevenue,  with  the  approval 
of  the  Secretary  of  the  Treasury,  shall  prescribe,  any 
producer  of  pure  sweet  wines  as  denned  by  this  Act 
may  withdraw  wine  spirits  from  any  special  bonded 
warehouse  in  original  packages  or  from  any  registered 
distillery  in  any  quantity  not  less  than  eighty  wine 
gallons,  and  may  use  so  much  of  the  same  as  may  be 
required  by  him  under  such  regulations,  and  after  the 
filing  of  such  notices  and  bonds  and  the  keeping  of 
such  records  and  the  rendition  of  such  reports  as  to 
materials  and  products  and  the  disposition  of  the  same 
as  the  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  shall  pre- 
scribe, in  fortifying  the  pure  sweet  wines  made  by  him, 
and  for  no  other  purpose,  in  accordance  with  the  fore- 
going limitations  and  provisions ;  and  the  Commissioner 
of  Internal  Revenue,  with  the  approval  of  the  Secre- 
tary of  the  Treasury,  is  authorized  whenever  he  shall 
deem  it  to  be  necessary  for  the  prevention  of  violations 
of  this  law  to  prescribe  that  wine  spirits  withdrawn 
under  this  section  shall  not  be  used  to  fortify  wines 
except  at  a  certain  distance  prescribed  by  him  from  any 
distillery,  rectifying  house,  winery,  or  other  establish- 
ment used  for  producing  or  storing  distilled  spirits, 
or  for  making  or  storing  wines  other  than  wines  which 
are  so  fortified,  and  that  in  the  building  in  which  such 
fortification  of  wines  is  practiced  no  wines  or  spirits 
other  than  those  permitted  by  this  regulation  shall  be 
stored  in  any  room  or  part  of  the  building  in  which 
fortification  of  wines  is  practiced.  The  use  of  wine 
spirits  for  the  fortification  of  sweet  wines  under  this 
Act  shall  be  under  the  immediate  supervision  of  an 
officer    of    internal  revenue,    who    shall    make    returns 


500  INCOME   AND   FEDERAL    TAX   REPORTS 

describing  the  kinds  and  quantities  of  wine  so  fortified, 
and  shall  affix  such  stamps  and  seals  to  the  packages 
containing  such  wines  as  may  be  prescribed  by  the 
Commissioner  of  Internal  Revenue,  with  the  approval 
of  the  Secretary  of  the  Treasury;  and  the  Commis- 
sioner of  Internal  Bevenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  shall  provide  by  regulations 
the  time  within  which  wines  so  fortified  with  the  wine 
spirits  so  withdrawn  may  be  subject  to  inspection,  and 
for  final  accounting  for  the  use  of  such  wine  spirits 
and  for  rewarehousing  or  for  payment  of  the  tax  on 
any  portion  of  such  wine  spirits  which  remain  not  used 
in  fortifying  pure  sweet  wines." 

(d)  That  under  such  regulations  and  upon  the  execu- 
tion of  such  notices,  entries,  bonds,  and  other  security 
as  the  Commissioner  of  Internal  Eevenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  may  pre- 
scribe, domestic  wines  subject  to  the  tax  imposed  by 
this  section  may  be  removed  from  the  winery  where 
produced,  free  of  tax,  for  storage  on  other  bonded 
premises  or  from  said  premises  to  other  bonded  prem- 
ises: Provided,  That  not  more  than  one  such  addi- 
tional removal  shall  be  allowed,  or  for  exportation 
from  the  United  States  or  for  use  as  distilling  material 
at  any  regularly  registered  distillery:  Provided,  how- 
ever, That  the  distiller  using  any  such  wine  as 
material  shall,  subject  to  the  provisions  of  section 
thirty-three  hundred  and  nine  of  the  Revised  Statutes 
of  the  United  States,  as  amended,  be  held  to  pay  the 
tax  on  the  product  of  such  wines  as  will  include  both 
the  alcoholic  strength  therein  produced  by  fermentation 
and  that  obtained  from  the  brandy  or  wine  spirits 
added  to  such  wines  at  the  time  of  fortification. 

(e)  That  upon  all  domestic  and  imported  sparkling 
wines,  liqueurs,  cordials,  and  similar  compounds  re- 
maining in  the  hands  of  dealers  when  this  section  takes 
effect,  or  thereafter  removed  from  the  place  of  manu- 


TAX    ON    BEVERAGES    LAW  501 

facture  or  storage  for  sale  or  consumption,  there  shall 
be  levied  and  paid,  by  stamp,  taxes  as  follows : 

On  each  bottle  or  other  container  of  champagne  or 
sparkling  wine,  3  cents  on  each  one-half  pint  or 
fraction  thereof. 

On  each  bottle  or  other  container  of  artificially  car- 
bonated wine,  V/2  cents  on  each  one-half  pint  or 
fraction  thereof. 

On  each  bottle  or  other  container  of  liqueurs,  cor- 
dials, or  similar  compounds,  by  whatever  name  sold 
or  offered  for  sale,  containing  sweet  wine,  fortified 
with  grape  brandy  under  the  provisions  of  paragraph 
(c)  of  this  section,  \y2  cents  on  each  one-half  pint  or 
fraction  thereof. 

The  taxes  imposed  by  this  section  shall  not  apply  to 
wines,  liqueurs,  or  cordials  on  which  the  tax  imposed 
by  the  Act  approved  October  twenty-second,  nineteen 
hundred  and  fourteen,  entitled  "An  Act  to  increase  the 
internal  revenue,  and  for  other  purposes,"  and  the 
joint  resolution  approved  December  seventeenth,  nine- 
teen hundred  and  fifteen,  entitled  "Joint  resolution 
extending  the  provisions  of  the  Act  entitled  'An  Act  to 
increase  the  internal  revenue,  and  for  other  purposes,' 
approved  October  twenty-second,  nineteen  hundred  and 
fourteen,  to  December  thirty-first,  nineteen  hundred 
and  sixteen,"  has  been  paid  by  stamp. 

The  Commissioner  of  Internal  Eevenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  is  hereby 
authorized  to  have  prepared  suitable  revenue  stamps 
denoting  the  payment  of  the  taxes  imposed  by  this 
section;  and  all  provisions  of  law  relating  to  internal- 
revenue  stamps,  so  far  as  applicable,  are  hereby 
extended  to  the  taxes  imposed  by  this  section:  Pro- 
vided, That  the  collection  of  the  tax  herein  prescribed 
on  imported  still  wines,  including  vermouth,  and  spark- 
ling wines,  including  champagne,  and  on  imported 
liqueurs,  cordials,  and  similar  compounds,  may  be  made 


502  INCOME   AND    FEDERAL    TAX   REPORTS 

within  the  discretion  of  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  by  assessment  instead  of  by  stamps. 

(/)  That  any  person  who  shall  evade  or  attempt  to 
evade  the  tax  imposed  by  this  section,  or  any  require- 
ment of  this  section  or  regulation  issued  pursuant 
thereof,  or  who  shall,  otherwise  than  provided  in  this 
section,  recover  or  attempt  to  recover  any  spirits  from 
domestic  or  imported  wine,  or  who  shall  rectify,  mix, 
or  compound  with  distilled  spirits  any  domestic  wines, 
other  than  in  the  manufacture  of  liqueurs,  cordials,  or 
similar  compounds  taxable  under  the  provisions  of  this 
section,  shall,  on  conviction,  be  punished  for  each  such 
offense  by  a  fine  of  not  exceeding  $5,000,  or  imprison- 
ment for  not  more  than  five  years,  or  both,  and  all 
wines,  spirits,  liqueurs,  cordials,  or  similar  compounds 
as  to  which  such  violation  occurs  shall  be  forfeited 
to  the  United  States.  But  the  provision  of  this  sub- 
division of  this  section  and  the  provision  of  section 
thirty-two  hundred  and  forty-four  of  the  Revised 
Statutes  of  the  United  States,  as  amended,  relating  to 
rectification,  or  other  internal-revenue  laws  of  the 
United  States,  shall  not  be  held  to  apply  to  or  prohibit 
the  mixing  or  blending  of  wines  subject  to  tax  under 
the  provisions  of  this  section  with  each  other  or  with 
other  wines  for  the  sole  purpose  of  perfecting  such 
wines  according  to  commercial  standards:  Provided, 
That  nothing  herein  contained  shall  be  construed  as 
prohibiting  the  use  of  tax-paid  grain  or  other  ethyl 
alcohol  in  the  fortification  of  sweet  wines  as  defined 
in  section  fifty- three  [401?]  of  this  Act. 

(g)  That  the  Commissioner  of  Internal  Revenue,  by 
regulations  to  be  approved  by  the  Secretary  of  the 
Treasury,  may  require  the  use  at  each  fruit  distillery 
of  such  spirit  meters,  and  such  locks  and  seals  to  be 
affixed  to  fermenters,  tanks,  or  other  vessels  and  to 
such    pipe    connections    as    may  in    his    judgment   be 


TAX    ON    BEVERAGES    LAW  503 

necessary  or  expedient;  and  the  said  commissioner  is 
hereby  authorized  to  assign  to  any  such  distillery  and 
to  each  winery  where  wines  are  to  be  fortified  such 
number  of  gaugers  or  storekeeper-gaugers  in  the  capac- 
ity of  gaugers  as  may  be  necessary  for  the  proper 
supervision  of  the  manufacture  of  brandy  or  the  mak- 
ing or  fortifying  of  wines  subject  to  tax  imposed  by 
this  section;  and  the  compensation  of  such  officers  shall 
not  exceed  $5  per  diem  while  so  assigned,  together  with 
their  actual  and  necessary  traveling  expenses,  and  also 
a  reasonable  allowance  for  their  board  bills,  to  be  fixed 
by  the  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  but  not 
to  exceed  $2.50  per  diem  for  said  board  bills. 

(h)  That  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury, 
is  hereby  authorized  to  make  such  allowances  for 
unavoidable  loss  of  wines  while  on  storage  or  during 
cellar  treatment  as  in  his  judgment  may  be  just  and 
proper,  and  to  prepare  all  necessary  regulations  for 
carrying  into  effect  the  provisions  of  this  section. 

(i)  That  the  second  paragraph  of  section  thirty- two 
hundred  and  sixty-four,  Revised  Statutes  of  the  United 
States  of  America,  as  amended  by  section  five  of  the 
Act  of  March  first,  eighteen  hundred  and  seventy-nine, 
and  as  further  amended  by  the  Act  of  Congress 
approved  June  twenty-second,  nineteen  hundred  and 
ten,  be  amended  so  as  to  read  as  follows: 

"In  all  surveys  forty-five  gallons  of  mash  or  beer 
brewed  or  fermented  from  grain  shall  represent  not 
less  than  one  bushel  of  grain,  and  seven  gallons  of 
mash  or  beer  brewed  or  fermented  from  molasses  shall 
represent  not  less  than  one  gallon  of  molasses,  except 
in  distilleries  operated  on  the  sour-mash  principle,  in 
which  distilleries  sixty  gallons  of  beer  brewed  or  fer- 
mented from  grain  shall  represent  not  less  than  one 
bushel  of  grain,  and  except  that  in  distilleries  where 


504  INCOME   AND    FEDERAL    TAX   REPORTS 

the  filtration-aeration  process  is  used,  with  the  ap- 
proval of  the  Commissioner  of  Internal  Revenue;  that 
is,  where  the  mash  after  it  leaves  the  mash  tub  is 
passed  through  a  filtering  machine  before  it  is  run 
into  the  fermenting  tub,  and  only  the  filtered  liquor  passes 
into  the  fermenting  tub,  there  shall  hereafter  be  no 
limitation  upon  the  number  of  gallons  of  water  which 
may  be  used  in  the  process  of  mashing  or  filtration 
for  fermentation;  but  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  in  order  to  protect  the  revenue,  shall  be 
authorized  to  prescribe  by  regulation,  to  be  made  by 
him,  such  character  of  survey  as  he  may  find  suitable 
for  distilleries  using  such  filtration-aeration  process. 
The  provisions  hereof  relating  to  filtration-aeration 
process  shall  apply  only  to  sweet-mash  distilleries." 

Spirits  removed  for  export. — Sec.  403.  That  under 
such  regulations  as  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  may  prescribe,  alcohol  or  other  distilled 
spirits  of  a  proof  strength  of  not  less  than  one  hundred 
and  eighty  degrees  intended  for  export  free  of  tax  may 
be  drawn  from  receiving  cisterns  at  any  distillery,  or 
from  storage  tanks  in  any  distillery  warehouse,  for 
transfer  to  tanks  or  tank  cars  for  export  from  the 
United  States,  and  all  provisions  of  existing  law  relat- 
ing to  the  exportation  of  distilled  spirits  not  inconsistent 
herewith  shall  apply  to  spirits  removed  for  export  under 
the  provisions  of  this  Act. 

Amendment  exempting  certain  distillers. — Sec.  404. 
That  section  thirty-two  hundred  and  fifty-five  of  the 
Revised  Statutes  as  amended  by  Act  of  June  third, 
eighteen  hundred  and  ninety-six,  and  as  further 
amended  by  Act  of  March  second,  nineteen  hundred 
and  eleven,  be  further  amended  so  as  to  read  as 
follows : 

"Sec.  3255.    The  Commissioner  of  Internal  Revenue, 


TAX    ON    BEVERAGES    LAW  505 

with  the  approval  of  the  Secretary  of  the  Treasury, 
may  exempt  distillers  of  brandy  made  exclusively  from 
apples,  peaches,  grapes,  pears,  pineapples,  oranges, 
apricots,  berries,  plums,  pawpaws,  persimmons,  prunes, 
figs,  or  cherries  from  any  provision  of  this  title  relat- 
ing to  the  manufacture  of  spirits,  except  as  to  the  tax 
thereon,  when  in  his  judgment  it  may  seem  expedient 
to  do  so:  Provided,  That  where,  in  manufacture  of 
wine,  artificial  sweetening  has  been  used  the  wine  or 
the  fruit  pomace  residuum  may  be  used  in  the  distilla- 
tion of  brandy,  as  [and?]  such  use  shall  not  prevent 
the  CommissioDer  of  Internal  Eevenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  from 
exempting  such  distiller  from  any  provision  of  this 
title  relating  to  the  manufacture  of  spirits,  except  as 
to  the  tax  thereon,  when  in  his  judgment  it  may  seem 
expedient  to  do  so:  And,  Provided  further,  That  the 
distillers  mentioned  in  this  section  may  add  to  not 
less  than  five  hundred  gallons  (or  ten  barrels)  of  grape 
cheese  not  more  than  five  hundred  gallons  of  a  sugar 
solution  made  from  cane,  beet,  starch,  or  corn  sugar, 
ninety-five  per  centum  pure,  such  solution  to  have  a 
saccharine  strength  of  not  to  exceed  ten  per  centum, 
and  may  ferment  the  resultant  mixture  on  a  winery 
or  distillery  premises,  and  such  fermented  product 
shall  be  regarded  as  distilling  material." 

Gin  bottled  in  bond  for  export. — Sec.  405.  That  dis- 
tilled spirits  known  commercially  as  gin  of  not  less 
than  eighty  per  centum  proof  may  at  any  time  within 
eight  years  after  entry  in  bond  at  any  distillery  be 
bottled  in  bond  at  such  distillery  for  export  without  the 
payment  of  tax,  under  such  rules  and  regulations  as 
the  Commissioner  of  Internal  Eevenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  may 
prescribe. 

Amendment — Penalties  for  removal  of  fermented  liquor 
tax  unpaid. — Sec.   406.     That  section   thirty-three  hun- 


506  INCOME    AND    FEDERAL    TAX    REPORTS 

dred  and  fifty-four  of  the  Eevised  Statutes  of  the 
United  States  as  amended  by  the  Act  approved  June 
eighteenth,  eighteen  hundred  and  ninety,  be,  and  is 
hereby,  amended  to  read  as  follows: 

"Sec.  3354.  Every  person  who  withdraws  any  fer- 
mented liquor  from  any  hogshead,  barrel,  keg,  or  other 
vessel  upon  which  the  proper  stamp  has  not  been  affixed 
for  the  purpose  of  bottling  the  same,  or  who  carries 
on  or  attempts  to  carry  on  the  business  of  bottling 
fermented  liquor  in  any  brewery  or  other  place  in 
which  fermented  liquor  is  made,  or  upon  any  premises 
having  communication  with  such  brewery,  or  any  ware- 
house, shall  be  liable  to  a  fine  of  $500,  and  the  property 
used  in  such  bottling  or  business  shall  be  liable  to  for- 
feiture: Provided,  however,  That  this  section  shall 
not  be  construed  to  prevent  the  withdrawal  and  trans- 
fer of  unfermented,  partially  fermented,  or  fermented 
liquors  from  any  of  the  vats  in  any  brewery  by  way 
of  a  pipe  line  or  other  conduit  to  another  building  or 
place  for  the  sole  purpose  of  bottling  the  same,  such 
pipe  line  or  conduit  to  be  constructed  and  operated  in 
such  manner  and  with  such  cisterns,  vats,  tanks,  valves, 
cocks,  faucets,  and  gauges,  or  other  utensils  or  appar- 
atus, either  on  the  premises  of  the  brewery  or  the  bot- 
tling house  and  with  such  changes  of  or  additions 
thereto,  and  such  locks,  seals,  or  other  fastenings,  and 
under  such  rules  and  regulations  as  shall  be  from  time 
to  time  prescribed  by  the  Commissioner  of  Internal 
Ee venue,  subject  to  the  approval  of  the  Secretary  of 
the  Treasury,  and  all  locks  and  seals  prescribed  shall 
be  provided  by  the  Commissioner  of  Internal  Revenue 
at  the  expense  of  the  United  States.  Provided  further, 
That  the  tax  imposed  in  section  thirty-three  hundred 
and  thirty-nine  of  the  Revised  Statutes  of  the  United 
States  shall  be  paid  on  all  fermented  liquor  removed 
from  a  brewery  to  a  bottling  house  by  means  of  a 
pipe  or  conduit,  at  the  time  of  such  removal,  by  the 


TAX    ON    BEVERAGES    LAW  507 

cancellation  and  defacement,  by  the  collector  of  the 
district  or  his  deputy,  in  the  presence  of  the  brewer, 
of  the  number  of  stamps  denoting  the  tax  on  the  fer- 
mented liquor  thus  removed.  The  stamps  thus  canceled 
and  defaced  shall  be  disposed  of  and  accounted  for 
in  the  manner  directed  by  the  Commissioner  of  Internal 
Eevenue,  with  the  approval  of  the  Secretary  of  the 
Treasury.  And  any  violation  of  the  rules  and  regula- 
tions hereafter  prescribed  by  the  Commissioner  of 
Internal  Revenue,  with  the  approval  of  the  Secretary 
of  the  Treasury,  in  pursuance  of  these  provisions,  shall 
be  subject  to  the  penalties  above  provided  by  this 
section.  Every  owner,  agent,  or  superintendent  of  any 
brewery  or  bottling  house  who  removes,  or  connives 
at  the  removal  of,  any  fermented  liquor  through  a  pipe 
line  or  conduit,  without  payment  of  the  tax  thereon,  or 
who  attempts  in  any  manner  to  defraud  the  revenue 
as  above,  shall  forfeit  all  the  liquors  made  by  and  for 
him,  and  all  the  vessels,  utensils,  and  apparatus  used 
in  making  the  same." 

Sec.  407.  [Occupational  taxes,  including  excise  tax 
on  corportions.     See  page  471.] 

Sec.  408.  [Special  tax  on  tobacco  manufacturers. 
See  page  473.] 

Administration. — Sec.  409.  That  all  administrative 
or  special  provisions  of  law,  including  the  law  relating 
to  the  assessment  of  taxes,  so  far  as  applicable,  are 
hereby  extended  to  and  made  a  part  of  this  title,  and 
every  person,  firm,  company,  corporation,  or  associa- 
tion liable  to  any  tax  imposed  by  this  title,  shall  keep 
such  records  and  render,  under  oath,  such  statements 
and  returns,  and  shall  comply  with  such  regulations 
as  the  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  may  from 
time  to  time  prescribe. 

Act  of  October  22,  1914,  repealed  in  part. — Sec.  410. 
That   the   Act  approved   October  twenty-second,   nine- 


508  INCOME    AND    FEDERAL    TAX    REPORTS 

teen  hundred  and  fourteen,  entitled,  "An  Act  to  in- 
crease the  internal  revenue,  and  for  other  purposes," 
and  the  joint  resolution  approved  December  seven- 
teenth, nineteen  hundred  and  fifteen,  entitled  "Joint 
resolution  extending  the  provisions  of  the  Act  entitled 
'An  Act  to  increase  the  internal  revenue,  and  for  other 
purposes,'  approved  October  twenty-second,  nineteen 
hundred  and  fourteen,  to  December  thirty-first,  nine- 
teen hundred  and  sixteen,"  are  hereby  repealed,  except 
sections  three  and  four  of  such  Act  as  so  extended, 
which  sections  shall  remain  in  force  till  January  first, 
nineteen  hundred  and  seventeen,  and  except  that  the 
provisions  of  the  said  Act  shall  remain  in  force  for 
the  assessment  and  collection  of  all  special  taxes 
imposed  by  sections  three  and  four  thereof,  or  by  such 
sections  as  extended  by  said  joint  resolution,  for  any 
year  or  part  thereof  ending  prior  to  January  first, 
nineteen  hundred  and  seventeen,  and  of  all  other  taxes 
imposed  by  such  Act,  or  by  such  Act  as  so  extended, 
accrued  prior  to  the  taking  effect  of  this  title,  and  for 
the  imposition  and  collection  of  all  penalties  or  forfeit- 
ures which  have  accrued  or  may  accrue  in  relation  to 
any  of  such  taxes. 

Redemption  of  unused  stamps. — Sec.  411.  That  the 
Commissioner  of  Internal  Eevenue,  subject  to  regula- 
tion prescribed  by  the  Secretary  of  the  Treasury,  may 
make  allowance  for  or  redeem  stamps,  issued,  under 
authority  of  the  Act  approved  October  twenty-second, 
nineteen  hundred  and  fourteen,  entitled  "An  Act  to 
increase  the  internal  revenue,  and  for  other  purposes," 
and  the  joint  resolution  approved  December  seven- 
teenth, nineteen  hundred  and  fifteen,  entitled  "Joint 
resolution  extending  the  provisions  of  the  Act  entitled 
'An  Act  to  increase  the  internal  revenue,  and  for  other 
purposes,'  approved  October  twenty-second,  nineteen 
hundred  and  fourteen,  to  December  thirty-first,  nine- 
teen hundred  and  sixteen,"  to  denote  the  payment  of 


TAX    ON    BEVERAGES   LAW  509 

internal  revenue  tax,  and  which  have  not  been  used,  if 
presented  within  two  years  after  the  purchase  of  such 
stamps. 

Act  effective  on  day  following  passage. — Sec.  412.  That 
the  provisions  of  this  title  shall  take  effect  on  the  day 
following  the  passage  of  this  Act,  except  where  other- 
wise in  this  title  provided. 

Sec.  413.  [Leaves  of  absence  for  internal  revenue 
officers.] 

Invalidating    Clause. 

Sec.  900  [of  the  general  revenue  Act  of  which  the 
above  Title  IV  is  a  part].  That  if  any  clause,  sen- 
tence, paragraph,  or  part  of  this  Act  shall  for  any 
reason  be  adjudged  by  any  court  of  competent  juris- 
diction to  be  invalid,  such  judgment  shall  not  affect, 
impair,  or  invalidate  the  remainder  of  said  Act,  but 
shall  be  confined  in  its  operation  to  the  clause,  sentence, 
paragraph,  or  part  thereof  directly  involved  in  the 
controversy  in  which  such  judgment  shall  have  been 
rendered. 

Sec.  902.  That  unless  otherwise  herein  specially 
provided  this  Act  shall  take  effect  on  the  day  following 
its  passage,  and  all  provisions  of  any  Act  or  Acts  incon- 
sistent with  the  provisions  of  this  Act,  are  hereby 
repealed. 

Approved  by  the  President,  September  8,  1916. 

TITLE  III.— WAR    TAX    ON   BEVERAGES1 

Additional  tax  on  distilled  spirits. — Sec.  300  [of  the 
general  revenue  Act  of  which  this  Title  is  a  part]. 
That  on  and  after  the  passage  of  this  Act  there  shall 
be  levied  and  collected  on  all  distilled  spirits  in  bond 

i  War  Tax  on  Beverages.  Being  Title  III  of  "An  Act  to  Provide  Revenue 
to  Defray  War  Expenses,  and  for  Other  Purposes."  Approved  October  3, 
1917.  (Public— No.  50— 65th  Congress.)  In  effect  October  4,  1917,  unless 
otherwise  specially  provided. 


510  INCOME    AND    FEDERAL    TAX    REPORTS 

at  that  time  or  that  have  been  or  that  may  be  then  or 
thereafter  produced  in  or  imported  into  the  United 
States,  except  such  distilled  spirits  as  are  subject  to 
the  tax  provided  in  section  three  hundred  and  three,  in 
addition  to  the  tax  now  imposed  by  law,  a  tax  of  $1.10 
(or,  if  withdrawn  for  beverage  purposes  or  for  use  in 
the  manufacture  or  production  of  any  article  used  or 
intended  for  use  as  a  beverage,  a  tax  of  $2.10)  on  each 
proof  gallon,  or  wine  gallon  when  below  proof,  and  a 
proportionate  tax  at  a  like  rate  on  all  fractional  parts 
of  such  proof  or  wine  gallon,  to  be  paid  by  the  distiller 
or  importer  when  withdrawn  and  collected  under  the 
provisions  of  existing  law. 

Additional  tax  on  imported  perfumes  containing  distilled 
spirits. — That  in  addition  to  the  tax  under  existing  law 
there  shall  be  levied  and  collected  upon  all  perfumes 
hereafter  imported  into  the  United  States  containing 
distilled  spirits,  a  tax  of  $1.10  per  wine  gallon,  and  a 
proportionate  tax  at  a  like  rate  on  all  fractional  parts 
of  such  wine  gallon.  Such  tax  shall  be  collected  by 
the  collector  of  customs  and  deposited  as  internal- 
revenue  collections,  under  such  rules  and  regulations  as 
the  Commissioner  of  Internal  Revenue,  with  the  ap- 
proval of  the  Secretary  of  the  Treasury  may  prescribe. 

Importing  of  distilled  spirits  for  beverage  purposes  pro- 
hibited.— Sec.  301.  That  no  distilled  spirits  produced 
after  the  passage  of  this  Act  shall  be  imported  into  the 
United  States  from  any  foreign  country,  or  from  the 
West  Indian  Islands  recently  acquired  from  Denmark 
(unless  produced  from  products  the  growth  of  such 
islands,  and  not  then  into  any  State  or  Territory  or  Dis- 
trict of  the  United  States  in  which  the  manufacture  or 
sale  of  intoxicating  liquor  is  prohibited),  or  from  Porto 
Rico,  or  the  Philippine  Islands.  Under  such  rules, 
regulations,  and  bonds  as  the  Secretary  of  the  Treasury 
may  prescribe,  the  provisions  of  this  section  shall  not 
apply  to  distilled  spirits  imported  for  other  than  (1) 


TAX    ON    BEVERAGES    LAW  511 

beverage  purposes  or  (2)  use  in  the  manufacture  or 
production  of  any  article  used  or  intended  for  use  as  a 
beverage. 

Removal  of  spirits  from  registered  distilleries. — Sec.  302. 
That  at  registered  distilleries  producing  alcohol,  or 
other  high-proof  spirits,  packages  may  be  filled  with 
such  spirits  reduced  to  not  less  than  one  hundred  proof 
from  the  receiving  cisterns  and  tax  paid  without  being 
entered  into  bonded  warehouse.  Such  spirits  may  also 
be  transferred  from  the  receiving  cisterns  at  such  dis- 
tilleries, by  means  of  pipe  lines,  direct  to  storage  tanks 
in  the  bonded  warehouse  and  may  be  warehoused  in 
such  storage  tanks.  Such  spirits  may  be  also  trans- 
ferred in  tanks  or  tank  cars  to  general  bonded  ware- 
houses for  storage  therein,  either  in  storage  tanks  in 
such  warehouses  or  in  the  tanks  in  which  they  were 
transferred.  Such  spirits  may  also  be  transferred 
after  tax  payment  from  receiving  cisterns  or  ware- 
house storage  tanks  to  tanks  or  tank  cars  and  may  be 
transported  in  such  tanks  or  tank  cars  to  the  premises 
of  rectifiers  of  spirits.  The  Commissioner  of  Internal 
Eevenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  is  hereby  empowered  to  prescribe  all  neces- 
sary regulations  relating  to  the  drawing  off,  trans- 
ferring, gauging,  storing  and  transporting  of  such 
spirits ;  the  records  to  be  kept  and  returns  to  be  made ; 
the  size  and  kind  of  packages  and  tanks  to  be  used; 
the  marking,  branding,  numbering  and  stamping  of 
such  packages  and  tanks;  the  kinds  of  stamps,  if  any, 
to  be  used ;  and  the  time  and  manner  of  paying  the  tax ; 
the  kind  of  bond  and  the  penal  sum  of  same.  The  tax 
prescribed  by  law  must  be  paid  before  such  spirits  are 
removed  from  the  distillery  premises,  or  from  general 
bonded  warehouse  in  the  case  of  spirits  transferred 
thereto,  except  as  otherwise  provided  by  law. 

Warehouse  regulations. — Under  such  regulations  as  the 
Commissioner  of  Internal  Revenue,  with  the  approval 


512  INCOME    AND    FEDERAL    TAX    REPORTS 

of  the  Secretary  of  the  Treasury,  may  prescribe,  dis- 
tilled spirits  may  hereafter  be  drawn  from  receiving 
cisterns  and  deposited  in  distillery  warehouses  without 
having  affixed  to  the  packages  containing  the  same  dis- 
tillery warehouse  stamps,  and  such  packages,  when  so 
deposited  in  warehouse,  may  be  withdrawn  therefrom 
on  the  original  gauge  where  the  same  have  remained  in 
such  warehouse  for  a  period  not  exceeding  thirty  days 
from  the  date  of  deposit. 

Exemptions  relating  to  ethyl  and  denatured  alcohol. — 
Under  such  regulations  as  the  Commissioner  of  In- 
ternal Eevenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  may  prescribe,  the  manufacture,  ware- 
housing, withdrawal,  and  shipment,  under  the  provisions 
of  existing  law,  of  ethyl  alcohol  for  other  than  (1)  bev- 
erage purposes  or  (2)  use  in  the  manufacture  or  produc- 
tion of  any  article  used  or  intended  for  use  as  a  beverage 
and  denatured  alcohol,  may  be  exempted  from  the  pro- 
visions of  section  thirty-two  hundred  and  eighty-three, 
Eevised  Statutes  of  the  United  States. 

Regulations  in  manufacture  of  ethyl  alcohol. — Under  such 
regulations  as  the  Commissioner  of  Internal  Eevenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  may 
prescribe,  manufacturers  of  ethyl  alcohol  for  other  than 
beverage  purposes  may  be  granted  permission  under  the 
provisions  of  section  thirty-two  hundred  and  eighty-five, 
Eevised  Statutes  of  the  United  States,  to  fill  fermenting 
tubs  in  a  sweet-mash  distillery  not  oftener  than  once  in 
forty-eight  hours. 

Floor  tax  imposed  upon  stocks  of  distilled  spirits. — 
Sec.  303.  That  upon  all  distilled  spirits  produced  in  or 
imported  into  the  United  States  upon  which  the  tax 
now  imposed  by  law  has  been  paid,  and  which,  on  the 
day  this  Act  is  passed,  are  held  by  a  retailer  in  a 
quantity  in  excess  of  fifty  gallons  in  the  aggregate, 
or  by  any  other  person,  corporation,  partnership,  or 
association  in  any  quantity,  and  which  are  intended  for 


TAX    ON    BEVERAGES   LAW  513 

sale,  there  shall  be  levied,  assessed,  collected,  and  paid 
a  tax  of  $1.10  (or,  if  intended  for  sale  for  beverage 
purposes  or  for  use  in  the  manufacture  or  production 
of  any  article  used  or  intended  for  use  as  a  beverage, 
a  tax  of  $2.10)  on  each  proof  gallon,  and  a  propor- 
tionate tax  at  a  like  rate  on  all  fractional  parts  of  such 
proof  gallon:  Provided,  That  the  tax  on  such  distilled 
spirits  in  the  custody  of  a  court  of  bankruptcy  in 
insolvency  proceedings  on  June  first,  nineteen  hundred 
and  seventeen,  shall  be  paid  by  the  person  to  whom 
the  court  delivers  such  distilled  spirits  at  the  time  of 
such  delivery,  to  the  extent  that  the  amount  thus  de- 
livered exceeds  the  fifty  gallons  hereinbefore  provided. 

War  tax  on  rectified  distilled  spirits  and  wines. — Sec. 
304.  That  in  addition  to  the  tax  now  imposed  or  im- 
posed by  this  Act  on  distilled  spirits  there  shall  be 
levied,  assessed,  collected,  and  paid  a  tax  of  15  cents 
on  each  proof  gallon  and  a  proportionate  tax  at  a  like 
rate  on  all  fractional  parts  of  such  proof  gallon  on  all 
distilled  spirits  or  wines  hereafter  rectified,  purified, 
or  refined  in  such  manner,  and  on  all  mixtures  here- 
after produced  in  such  manner,  that  the  person  so 
rectifying,  purifying,  refining,  or  mixing  the  same  is 
a  rectifier  within  the  meaning  of  section  thirty-two 
hundred  and  forty-four,  Revised  Statutes,  as  amended, 
and  on  all  such  articles  in  the  possession  of  the  recti- 
fier on  the  day  this  Act  is  passed: 

Provided,  That  this  tax  shall  not  apply  to  gin  pro- 
duced by  the  redistillation  of  a  pure  spirit  over  juniper 
berries  and  other  aromatics. 

Dilution  prohibited. — When  the  process  of  rectifica- 
tion is  completed  and  the  tax  prescribed  by  this  section 
has  been  paid,  it  shall  be  unlawful  for  the  rectifier 
or  any  other  dealer  to  reduce  in  proof  or  increase  in 
volume  such  spirits  or  wine  by  the  addition  of  water 
or  other  substance;  nothing  herein  contained  shall, 
however,  prevent  a  rectifier  from  using  again  in  the 


514  INCOME    AND    FEDERAL    TAX   REPORTS 

process    of    rectification    spirits    already  rectified    and 
upon  which  the  tax  has  theretofore  been  paid. 

Exemptions  from  war  tax. — The  tax  imposed  by  this 
section  shall  not  attach  to  cordials  or  liqueurs  on  which 
a  tax  is  imposed  and  paid  under  the  Act  entitled  "An 
Act  to  increase  the  revenue,  and  for  other  purposes," 
approved  September  eighth,  nineteen  hundred  and  six- 
teen, nor  to  the  mixing  and  blending  of  wines,  where 
such  blending  is  for  the  sole  purpose  of  perfecting 
such  wines  according  to  commercial  standards,  nor  to 
blends  made  exclusively  of  two  or  more  pure  straight 
whiskies  aged  in  wood  for  a  period  not  less  than  four 
years  and  without  the  addition  of  coloring  or  flavoring 
matter  or  any  other  substance  than  pure  water  and 
if  not  reduced  below  ninety  proof:  Provided,  That 
such  blended  whiskies  shall  be  exempt  from  tax  under 
this  section  only  when  compounded  under  the  imme- 
diate supervision  of  a  revenue  officer,  in  such  tanks 
and  under  such  conditions  and  supervision  as  the  Com- 
missioner of  Internal  Kevenue,  with  the  approval  of 
the  Secretary  of  the  Treasury,  may  prescribe. 

Distilled  spirits  subject  to  uniform  regulations. — All 
distilled  spirits  taxable  under  this  section  shall  be  sub- 
ject to  uniform  regulations  concerning  the  use  thereof 
in  the  manufacture,  blending,  compounding,  mixing, 
marking,  branding,  and  sale  of  whiskey  and  rectified 
spirits,  and  no  discrimination  whatsoever  shall  be  made 
by  reason  of  a  difference  in  the  character  of  the  mate- 
rial from  which  same  may  have  been  produced. 

Rectifier  subject  to  regulations  of  Commissioner  of 
Internal  Revenue. — The  business  of  a  rectifier  of  spirits 
shall  be  carried  on,  and  the  tax  on  rectified  spirits 
shall  be  paid,  under  such  rules,  regulations,  and  bonds 
as  may  be  prescribed  by  the  Commissioner  of  Internal 
.Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury. 


TAX    ON    BEVERAGES    LAW  515 

Penalties. — Any  person  violating  any  of  the  provis- 
ions of  this  section  shall  be  deemed  to  be  guilty  of  a 
misdemeanor  and,  upon  conviction,  shall  be  fined  not 
more  than  $1,000  or  imprisoned  not  more  than  two 
years.  He  shall,  in  addition,  be  liable  to  double  the 
tax  evaded  together  with  the  tax,  to  be  collected  by 
assessment  or  on  any  bond  given. 

Stamp  regulations. — Sec,  305.  That  hereafter  col- 
lectors of  internal  revenue  shall  not  furnish  wholesale 
liquor  dealer's  stamps  in  lieu  of  and  in  exchange  for 
stamps  for  rectified  spirits  unless  the  package  covered 
by  stamp  for  rectified  spirits  is  to  be  broken  into 
smaller  packages. 

The  Commissioner  of  Internal  Eevenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  is  author- 
ized to  discontinue  the  use  of  the  following  stamps 
whenever  in  his  judgment  the  interests  of  the  Govern- 
ment will  be  subserved  thereby : 

Distillery  warehouse,  special  bonded  warehouse, 
special  bonded  rewarehouse,  general  bonded  warehouse, 
general  bonded  retransfer,  transfer  brandy,  export 
tobacco,  export  cigars,  export  oleomargarine  and 
export  fermented  liquor  stamps. 

Commissioner  may  require  installation  of  revenue-pro- 
tecting apparatus. — Sec.  306.  That  the  Commissioner 
of  Internal  Eevenue,  with  the  approval  of  the  Secre- 
tary of  the  Treasury,  is  hereby  authorized  to  require 
at  distilleries,  breweries,  rectifying  houses,  and 
wherever  else  in  his  judgment  such  action  may  be 
deemed  advisable,  the  installation  of  meters,  tanks, 
pipes,  or  any  other  apparatus  for  the  purpose  of  pro- 
tecting the  revenue,  and  such  meters,  tanks,  and  pipes 
and  all  necessary  labor  incident  thereto  shall  be  at  the 
expense  of  the  person,  corporation,  partnership,  or 
association  on  whose  premises  the  installation  is  re- 
quired. Any  such  person,  corporation,  partnership,  or 
association    refusing     or    neglecting    to    install     such 


516  INCOME    AND    FEDERAL    TAX    REPORTS 

apparatus  when  so  required  by  the  commissioner  shall 
not  be  permitted  to  conduct  business  on  such  premises. 

War  tax  on  beer,  ale,  porter,  etc. — Sec.  307.  That  on 
and  after  the  passage  of  this  Act  there  shall  be  levied 
and  collected  on  all  beer,  lager  beer,  ale,  porter,  and 
other  similar  fermented  liquor,  containing  one-half  per 
centum  or  more  of  alcohol,  brewed  or  manufactured 
and  sold,  or  stored  in  warehouse,  or  removed  for  con- 
sumption or  sale,  within  the  United  States,  by  whatever 
name  such  liquors  may  be  called,  in  addition  to  the  tax 
now  imposed  by  law,  a  tax  of  $1.50  for  every  barrel 
containing  not  more  than  thirty-one  gallons,  and  at  a 
like  rate  for  any  other  quantity  or  for  the  fractional 
parts  of  a  barrel  authorized  and  denned  by  law. 

Removal  from  brewery  to  distillery. — Sec.  308.  That 
from  and  after  the  passage  of  this  Act  taxable  fer- 
mented liquors  may  be  conveyed  without  payment  of 
tax  from  the  brewery  premises  where  produced  to  a 
contiguous  industrial  distillery  of  either  class  estab- 
lished under  the  Act  of  October  third,  nineteen  hundred 
and  thirteen,  to  be  used  as  distilling  material,  and  the 
residue  from  such  distillation,  containing  less  than 
one-half  of  one  per  centum  of  alcohol  by  volume,  which 
is  to  be  used  in  making  beverages,  may  be  manipulated 
by  cooling,  flavoring,  carbonating,  settling,  and  filter- 
ing on  the  distillery  premises  or  elsewhere. 

The  removal  of  the  taxable  fermented  liquor  from 
the  brewery  to  the  distillery  and  the  operation  of  the 
distillery  and  removal  of  the  residue  therefrom  shall 
be  under  the  supervision  of  such  officer  or  officers  as 
the  Commissioner  of  Internal  Revenue  shall  deem 
proper,  and  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury, 
is  hereby  authorized  to  make  such  regulations  from 
time  to  time  as  may  be  necessary  to  give  force  and 
effect  to  this  section  and  to  safeguard  the  revenue. 


TAX    ON    BEVERAGES    LAW  517 

Tax  doubled  on  still  wines,  champagnes,  etc. — Sec.  309. 
That  upon  all  still  wines,  including  vermuth,  and  upon 
all  champagne  and  other  sparkling  wines,  liqueurs, 
cordials,  artificial  or  imitation  wines  or  compounds 
sold  as  wine,  produced  in  or  imported  into  the  United 
States,  and  hereafter  removed  from  the  custom-house, 
place  of  manufacture,  or  from  bonded  premises  for 
sale  or  consumption,  there  shall  be  levied  and  collected, 
in  addition  to  the  tax  now  imposed  by  law  upon  such 
articles,  a  tax  equal  to  such  tax,  to  be  levied,  collected, 
and  paid  under  the  provisions  of  existing  law. 

Floor  tax  on  excess  stocks  of  still  wines,  etc. — Sec.  310. 
That  upon  all  articles  specified  in  section  three  hundred 
and  nine  upon  which  the  tax  now  imposed  by  law  has 
been  paid  and  which  are  on  the  day  this  Act  is  passed 
held  in  excess  of  twenty-five  gallons  in  the  aggregate 
of  such  articles  add  intended  for  sale,  there  shall  be 
levied,  collected,  and  paid  a  tax  equal  to  the  tax 
imposed  by  such  section. 

Withdrawal  of  grape  brandy  or  wine  spirits. — Sec.  311. 
That  upon  all  grape  brandy  or  wine  spirits  with- 
drawn by  a  producer  of  wines  from  any  fruit  distillery 
or  special  bonded  warehouse  under  subdivision  (c)  of 
section  four  hundred  and  two  of  the  Act  entitled  "An 
Act  to  increase  the  revenue,  and  for  other  purposes," 
approved  September  eighth,  nineteen  hundred  and  six- 
teen, there  shall  be  levied,  assessed,  collected,  and  paid 
in  addition  to  the  tax  therein  imposed,  a  tax  equal 
to  double  such  tax,  to  be  assessed,  collected,  and  paid 
under  the  provisions  of  existing  law. 

Floor  tax  on  sweet  wines  as  fortified. — Sec.  312.  That 
upon  all  sweet  wines  held  for  sale  by  the  producer 
thereof  upon  the  day  this  Act  is  passed  there  shall 
be  levied,  assessed,  collected,  and  paid  an  additional 
tax  equivalent  to  10  cents  per  proof  gallon  upon  the 
grape  brandy  or  wine  spirits  used  in  the  fortification  of 
such  wine,  and  an  additional  tax  of  20  cents  per  proof 


518  INCOME    AND    FEDERAL    TAX    REPORTS 

gallon  shall  be  levied,  assessed,  collected,  and  paid 
upon  all  grape  brandy  or  wine  spirits  withdrawn  by  a 
producer  of  sweet  wines  for  the  purpose  of  fortifying 
such  wines  and  not  so  used  prior  to  the  passage  of 
this  Act. 

Sirups  and  extracts  in  manufacture  of  soft  drinks. — Sec. 
313.  That  there  shall  be  levied,  assessed,  collected, 
and  paid — 

(a)  Upon  all  prepared  sirups  or  extracts  (intended 
for  use  in  the  manufacture  or  production  of  beverages, 
commonly  known  as  soft  drinks,  by  soda  fountains, 
bottling  establishments,  and  other  similar  places)  sold 
by  the  manufacturer,  producer,  or  importer  thereof, 
if  so  sold  for  not  more  than  $1.30  per  gallon,  a  tax  of 
5  cents  per  gallon;  if  so  sold  for  more  than  $1.30  and 
not  more  than  $2  per  gallon,  a  tax  of  8  cents  per 
gallon;  if  so  sold  for  more  than  $2  and  not  more  than 
$3  per  gallon,  a  tax  of  10  cents  per  gallon;  if  so  sold 
for  more  than  $3  and  not  more  than  $4  per  gallon,  a 
tax  of  15  cents  per  gallon;  and  if  so  sold  for  more 
than  $4  per  gallon,  a  tax  of  20  cents  per  gallon;  and 

Soft  drinks. — (b)  Upon  all  unfermented  grape  juice, 
soft  drinks  or  artificial  mineral  waters  (not  carbon- 
ated), and  fermented  liquors  containing  less  than  one- 
half  per  centum  of  alcohol,  sold  by  the  manufacturer, 
producer,  or  importer  thereof,  in  bottles  or  other  closed 
containers,  and  upon  all  ginger  ale,  root  beer,  sarsapar- 
illa,  pop,  and  other  carbonated  waters  or  beverages, 
manufactured  and  sold  by  the  manufacturer,  producer, 
or  importer  of  the  carbonic  acid  gas  used  in  carbonat- 
ing  the  same,  a  tax  of  1  cent  per  gallon;  and 

Natural  mineral  or  table  waters. — (c)  Upon  all  natural 
mineral  waters  or  table  waters,  sold  by  the  producer, 
bottler,  or  importer  thereof,  in  bottles  or  other  closed 
containers,  at  over  10  cents  per  gallon,  a  tax  of  1  cent 
per  gallon. 


TAX    ON    BEVERAGES    LAW  519 

Monthly  returns  by  manufacturer,  bottler,  importer,  etc., 
of  sirups,  soft  drinks,  and  natural  mineral  waters. — Sec.  314. 
That  each  such  manufacturer,  producer,  bottler,  or  im- 
porter shall  make  monthly  returns  under  oath  to  the  col- 
lector of  internal  revenue  for  the  district  in  which  is  lo- 
cated the  principal  place  of  business,  containing  such  in- 
formation necessary  for  the  assessment  of  the  tax,  and 
at  such  times  and  in  such  manner,  as  the  Commissioner 
of  Internal  Revenue,  with  the  approval  of  the  Secretary 
of  the  Treasury,  may  by  regulation  prescribe. 

Carbonic  Acid  Gas. — Sec.  315.  That  upon  all  carbonic 
acid  gas  in  drums  or  other  containers  (intended  for 
use  in  the  manufacture  or  production  of  carbonated 
water  or  other  drinks)  sold  by  the  manufacturer,  pro- 
ducer, or  importer  thereof,  there  shall  be  levied, 
assessed,  collected,  and  paid  a  tax  of  5  cents  per  pound. 
Such  tax  shall  be  paid  by  the  purchaser  to  the  vendor 
thereof  and  shall  be  collected,  returned,  and  paid  to 
the  United  States  by  such  vendor  in  the  same  manner 
as  provided  in  section  five  hundred  and  three. 

Approved  by  the  President,  October  3,  1917. 


CHAPTER  XXV 
WAR  STAMP  TAXES 

What  is  taxed. — Bonds  of  indebtedness,  debentures  or 
certificates  of  indebtedness;  bonds  of  indemnity  and 
surety;  capital  stock  issues;  capital  stock  sales  and 
transfers;  produce  sales  on  exchanges  or  boards  of 
trade;  drafts  or  checks  payable  otherwise  than  at  sight 
or  on  demand;  promissory  notes;  conveyances;  deeds; 
instruments  conveying  lands,  tenements  or  other  realty; 
entry  of  goods  at  customhouse,  entry  for  withdrawal 
of  goods  from  customs  bonded  warehouses;  passage 
tickets  to  foreign  ports  except  in  Canada  or  Mexico; 
voting  proxies;  powers  of  attorney;  and  parcels  post 
packages  are  subject  to  a  stamp  tax  on  and  after  De- 
cember 1,  1917,  under  Title  VIII  of  the  Act  of  October 
3,  1917. 

Playing  cards  are  also  subjected  to  an  additional  tax, 
effective  on  and  after  Oct.  4,  1917. 

The  rate  of  tax  and  method  of  payment  in  each  case 
will  be  given  in  following  sections  of  this  chapter,  each 
class  of  document  or  article  subject  to  tax  being  treated 
in  a  separate  section. 

Who  pays  the  tax. — In  the  case  of  documents  requiring 
the  tax  stamp  affixed,  the  tax  is  intended  to  be  paid  by 
the  person1  who  makes  or  issues  the  instrument,  but  the 
penalty  provided  is  equally  upon  the  person  who  accepts 
a  taxable  instrument  upon  which  the  tax  stamps  have 
not  been  duly  affixed. 

In  the  case  of  parcel  post  packages,  the  tax  is  paid 

i  "Person"  includes  "corporation,"  "partnership,"  and  association. 

520 


WAR   STAMP   TAXES  521 

by  the  sender  of  the  package,  and  without  the  payment 
of  the  tax  the  package  will  not  be  transported. 

In  the  case  of  playing  cards  the  tax  is  to  be  paid  by 
the  manufacturer  or  importer. 

Exemptions. — The  tax  does  not  attach  to  any  bond,  note 
or  other  instrument  issued  by  the  United  States  or  by 
any  foreign  government,  or  by  any  State,  Territory  or 
the  District  of  Columbia  or  local  subdivision  thereof, 
or  municipal  or  other  corporation  exercising  the  taxing 
power,  when  issued  in  the  exercise  of  a  strictly  govern- 
mental, taxing  or  municipal  function. 

Bonds  given  by  officials  of  a  State,  township,  county 
or  village,  for  the  faithful  performance  of  duties,  and 
any  bonds  given  to  the  same  political  subdivisions  cov- 
ering contracts  for  governmental  purposes  or  the  pro- 
tection of  the  State,  township,  county,  village  or  munici- 
pality, in  any  respect,  are  held  to  be  free  from  Federal 
taxation  on  the  broad  ground  that  the  sovereign  States 
and  subdivisions  thereof  are  constitutionally  free  from 
taxation  by  the  Federal  Government.  This  ruling  does 
not  apply  to  bonds  otherwise  taxable  given  to  the  Fed- 
eral Government  for  any  purpose. 

Government  officers  and  employees  should  be  careful 
not  to  pay  the  tax,  as  they  can  not  be  reimbursed  by  the 
Department  of  Commerce  for  such  payments  inadver- 
tently made. 

Exemption  is  provided  also  for  stocks  and  bonds  is- 
sued by  cooperative  building  and  loan  associations 
which  are  organized  and  operated  exclusively  for  the 
benefit  of  their  members  and  make  loans  only  to  their 
shareholders.  Stocks  and  bonds  issued  by  mutual  ditch 
or  irrigating  companies  are  also  exempt. 

Checks  and  drafts  payable  at  sight  or  on  demand  are 
not  taxed.  This  exemption  does  not  apply,  however,  to 
promissory  notes. 

Bank  notes  intended  for  circulation  are  exempt. 


522  INCOME    AND    FEDERAL    TAX    REPORTS 

Bonds  of  indebtedness. — Tax  is  imposed  on  bonds  of  in- 
debtedness as  follows :  "Bonds,  debentures  or  certificates 
of  indebtedness  issued  on  and  after  the  first  day  of  De- 
cember, nineteen  hundred  and  seventeen,  by  any  person, 
corporation,  partnership  or  association,  on  each  $100  of 
face  value  or  fraction  thereof,  5  cents:  Provided,  that 
every  renewal  of  the  foregoing  shall  be  taxed  as  a  new 
issue:  Provided,  further,  that  when  a  bond  conditioned 
for  the  repayment  or  payment  of  money  is  given  in  a 
penal  sum  greater  than  the  debt  secured,  the  tax  shall 
be  based  upon  the  amount  secured." 

A  bond  is  a  written  promise,  under  seal,  to  pay  a  speci- 
fied sum  of  money  at  a  fixed  time  in  the  future,  and,  in 
the  case  of  corporate  or  municipal  issues,  is  usually  one 
of  a  series  of  similar  bonds  all  carrying  interest  at  a 
fixed  rate.  Each  bond  contains  certain  provisons  as  to 
the  time,  place  and  manner  of  these  payments,  and  usu- 
ally refers  to  the  mortgage,  if  any,  made  to  insure  their 
fulfillment  or  to  the  law,  if  any,  authorizing  the  issue. 

While  bonds  may  be  issued  by  individuals,  partner- 
ships and  associations,  as  well  as  by  corporations,  their 
use  is  largely  confined  to  corporations  (and  government 
or  municipal  bodies),  since  the  length  of  time  usually  in- 
volved makes  the  bonds  of  an  individual,  in  the  judg- 
ment of  the  market,  an  uncertain  investment. 

The  tax  on  bonds  is  only  upon  issue  or  renewal  on  and 
after  December  1,  1917.  Subsequent  sale  or  transfer  of 
the  bond  is  not  taxable. 

"Issue"  means  the  first  delivery  of  the  instrument, 
complete  in  form,  to  the  person  who  takes  it  as  a  holder. 

"Eenewal,"  strictly  speaking,  refers  to  a  new  issue 
supplanting  the  old,  in  which  some  change  is  made  in 
the  agreement,  as  to  time  of  payment,  rate  of  interest, 
security  or  other  matters.  It  is  to  be  presumed  that  ex- 
tended bonds  will  be  classed  as  renewed,  for  the  purpose 
of  the  tax.  Extended  or  continued  bonds  may  be,  for 
example,  either  (1)  a  new  issue  with  extended  date  of 


WAR   STAMP   TAXES  523 

maturity  given  to  the  holders  of  outstanding  bonds  in 
exchange  for  the  old  ones,  in  a  reorganization  or  read- 
justment of  a  corporation,  or  (2)  the  same  bonds  may 
be  retained  and  coupons  issued  for  an  additional  interest 
period.    Bonds  are  then  "stamped." 

A  literal  construction  of  the  clause  in  regard  to  re- 
newal of  bonds,  etc.,  "Provided  further,  that  every  re- 
newal of  the  foregoing  shall  be  taxed  as  a  new  issue," 
would  impose  the  renewal  tax  only  upon  the  "foregoing," 
which  word  refers,  literally,  to  "bonds,  debentures  or 
certificates  of  indebtedness  issued  on  and  after  Decem- 
ber 1,  1917."  Under  such  a  construction,  renewals  of 
bonds  which  were  first  issued  prior  to  that  date  would 
not  be  taxable,  but  it  is  held  that  the  intent  of  the  law 
was  to  tax  all  renewals  of  bonds,  regardless  of  when 
the  bonds  were  first  issued. 

In  the  case  of  organization  or  reorganization  of  a  cor- 
poration, "temporary  bonds"  may  be  issued,  pending 
the  issue  of  the  regular  bonds.  Such  interim  or  tem- 
porary bonds  are  really  a  substitute  for  the  permanent 
bond,  and  contain  the  essential  recitals.  They  would  be 
taxable,  and  if  the  tax  were  duly  paid,  might  be  sold 
or  transferred  or  exchanged  for  the  regular  bonds, 
either  by  the  original  owner  or  by  a  new  owner,  without 
additional  tax,  since  the  tax  does  not  attach  to  sale  or 
transfer  of  a  bond,  and  it  would  therefore  not  attach 
to  the  sale  or  transfer  of  a  substitute  for  the  bond. 

Temporary  receipts  would  be  classed  with  temporary 
bonds  and  be  subject  to  the  same  conditions.  A  tem- 
porary receipt,  strictly  speaking,  is  a  formal  acknowl- 
edgment by  a  banking  house,  trust  company  or  the  issu- 
ing corporation  of  the  payment  for  a  bond  not  yet  pre- 
pared for  delivery  and  the  promise  to  deliver  the  bond, 
when  prepared,  on  surrender  of  the  receipt  at  the  proper 
offices.  The  distinction  ordinarily  made  between  a  tem- 
porary receipt  and  a  temporary  bond  is  that  the  latter 


524  INCOME   AND    FEDERAL    TAX    REPORTS 

is  not  merely  an  acknowledgment  of  value  received,  but 
is  a  substitute  for  the  regular  bond. 

Certificates  of  deposit  of  money  issued  by  banks  and 
trust  companies  are  not  taxable,  whether  they  are  time 
certificates  or  whether  they  contain  a  certain  clause  re- 
serving the  right  of  requiring  thirty  days'  notice  for 
payment. 

Certificates  of  deposit  issued  by  a  depositary  upon 
receiving  bonds  or  other  securities  deposited  under  a 
reorganization  agreement  would,  generally  speaking,  be 
taxable  if  designed  to  serve  as  a  substitute  for  a  taxable 
security.  There  is  no  tax  upon  a  contract  or  agreement 
by  a  corporation  to  issue  stock. 

Debentures.— -Although  in  England  the  term  "deben- 
ture" implies  a  charge  upon  property  of  the  issuing  cor- 
poration, the  word  is  used  in  the  United  States  to  desig- 
nate a  bond  without  specific  security,  which  rests  merely 
upon  the  general  credit  of  the  company.  This  is  not  true 
of  debentures  of  a  financial  company,  however,  which 
are  by  law  required  to  be  secured.  Debentures  are 
classed  with  bonds  for  the  purpose  of  the  tax,  which  at- 
taches, as  in  the  case  of  bonds,  only  upon  issue  or  re- 
newal, and  not  upon  subsequent  sale  or  transfer. 

Certificates  of  indebtedness. — Certificates  of  indebted- 
ness, as  contemplated  by  the  tax,  are  formally  executed 
corporate  promises  to  pay  a  fixed  sum  of  money  in  the 
future.  If  such  certificates  are  issued  under  seal  and 
have  a  far-distant  date  of  maturity  they  would  be  classed 
with  bonds.  Short  term  promises  to  pay,  not  under  seal, 
would  be  classed  as  promissory  notes. 

Trust  certificates,  stock  trust  certificates  and  stock  inter- 
est certificates. — The  foregoing  should  be  classed  with 
bonds  where  there  is  an  obligation  cited  to  pay  princi- 
pal, interest  or  both. 

Indemnity  and  surety  bonds. — The  tax  on  bonds  for  in- 
demnifying any  person  or  concern  as  surety,  and  on 
bonds  for  the  due  performance  of  contracts,  when  no 


WAR    STAMP    TAXES  525 

premium  or  fee  is  paid  for  the  issuance  of  the  bond,  is 
50  cents  for  each  bond. 

If  a  premium  is  charged  for  the  execution  of  the  bond, 
the  tax  is  based  on  the  amount  of  the  premium  and  is 
at  the  rate  of  1  cent  for  each  $1  or  fractional  part  there- 
of of  the  premium  charged.  The  rate  and  amount  of 
premium  charged  should  be  stated  on  the  bond,  so  that 
correctness  of  tax  may  be  verified.  Policies  of  reinsur- 
ance are  exempt.  Bonds  required  in  legal  proceedings 
are  not  taxable. 

Capital  stock — original  issue. — Stock  certificates,  evi- 
dencing the  stockholder's  ownership  interest  in  the  issu- 
ing association,  company  or  corporation,  are  taxable,  like 
bonds,  at  the  time  of  issue  or  renewal,  and  in  addition, 
are  taxable  upon  sale  or  transfer.  In  the  case  of  capital 
stock  with  face  value,  issued  upon  organization  or  upon 
reorganization  of  any  non-exempt  association,  company 
or  corporation  on  or  after  December  1,  1917,  a  tax  is 
imposed  of  5  cents  for  each  $100  or  fraction  thereof  of 
face  value.  In  the  case  of  stock  without  face,  or  par, 
value,  the  tax  is  5  cents  for  each  share,  provided,  that 
if  the  actual  market  value  of  such  stock  exceeds  $100 
per  share  the  tax  will  be  5  cents  for  each  $100  or  fraction 
thereof  of  the  total  actual  value. 

For  example,  in  the  case  of  stock  with  face  value,  the 
basis  of  the  tax  would  be  the  total  face  value  of  the 
shares  issued,  regardless  of  the  face  value  of  the  indi- 
vidual shares,  which  might  be  $5,  $50  or  $100,  without 
affecting  the  amount  of  the  tax.  In  the  case  of  non-par 
shares,  however,  if  the  actual  value  is  less  than  $100 
per  share,  the  tax  is  5  cents  upon  each  individual  share. 

In  all  cases  of  issue  of  capital  stock,  the  stamps  de- 
noting the  payment  of  the  tax  must  be  attached  to  the 
stock  books  and  not  to  the  certificates  themselves. 
Where  there  are  no  stubs  or  stock  books,  but  loose  cer- 
tificates are  issued,  the  stamps  must  be  affixed  to  the 
books  of  record  in  which  the  issues  are  recorded. 


INCOME   AND    FEDERAL    TAX   REPORTS 

Ad  interim  stock  certificates. — Issues  of  interim  certifi- 
cates, that  is,  certificates  entitling  the  holder  thereof  to 
receive  stock  when,  as  and  if  issued,  pending  stock  issue 
of  corporations  organized  or  reorganized  on  or  after 
December  1, 1917,  are  subject  to  a  tax  of  5  cents  on  each 
$100  of  face  value  or  fraction  thereof.  Subsequent  ex- 
change of  such  interim  for  regular  stock  certificates  will 
not  be  subject  to  tax,  but  if  meanwhile  the  interim  cer- 
tificate is  sold  or  transferred  a  sale  or  transfer  tax  must 
be  paid.  There  is  no  stamp  tax  upon  articles  of  incor- 
poration, applications  for  the  issuance  of  corporate 
charters,  contracts  for  the  performance  of  services,  or 
upon  contracts  or  agreements  by  a  corporation  to  issue 
stock. 

Capital  stock  sales,  transfers,  or  agreements  to  sell. — A 
tax  of  2  cents  on  each  $100  of  face  value  or  fraction 
thereof,  or  in  the  case  of  stock  without  par  value,  2  cents 
on  each  share,  or  if  value  exceeds  $100  per  share,  2  cents 
upon  each  $100  of  actual  value,  or  fraction  thereof,  is 
imposed  upon  all  sales,  or  agreements  to  sell,  or  memo- 
randa of  sales  or  deliveries  of,  or  transfer  of  legal  title 
to  shares  of  certificates  of  stock  in  any  association,  com- 
pany or  corporation,  whether  made  upon  or  shown  by 
the  books  of  the  company,  or  by  assignment  in  blank,  or 
by  any  delivery,  paper,  agreement,  memorandum  or 
other  evidence  of  transfer  or  sale,  whether  entitling  the 
holder  in  any  manner  to  the  benefit  of  such  stock  or  not. 

In  computing  the  tax  on  such  sales  or  transfers  of 
stock,  the  basis  is  the  total  face,  or  par,  value  of  all  the 
shares  involved  in  a  single  transaction,  even  though  the 
shares  are  represented  by  several  different  certificates. 
The  amount  of  the  tax  would  be  the  same  upon  a  trans- 
fer of  ten  $50  shares  as  it  would  be  upon  that  of  five  $100 
shares,  that  is  10  cents,  or  2  cents  for  each  $100  of  face 
value  or  fraction  thereof. 

It  must  be  noted,  however,  that  in  the  case  of  stock 
without  face,  or  par,  value,  the  tax  upon  sale  or  transfer 


WAR   STAMP   TAXES  527 

is  2  cents  for  each  share,  unless  the  actual  value  of  each 
share  exceeds  $100,  in  which  case  the  tax  is  the  same  as 
upon  shares  with  face  value — 2  cents  for  each  $100  or 
fraction  thereof  involved  in  the  total  transaction.  The 
valuation  of  non-par  stock  is  to  be  determined  by  the 
actual,  sale,  or  market  value. 

The  tax  upon  transfer  or  sale  of  stock  must  be  paid 
regardless  of  whether  the  transfer  is  made  before  or 
after  the  issuance  of  the  original  certificate. 

Where  a  corporation  organized  under  the  laws  of 
Canada  or  any  other  foreign  country  issues  stock  in  the 
United  States  on  and  after  December  1,  1917,  such  stock 
is  subject  to  tax. 

The  tax  is  not  imposed  upon  the  deposit  of  stock  cer- 
tificates as  collateral  security  for  money  loaned  thereon 
nor  upon  an  agreement  relating  to  such  deposit,  unless 
the  stock  is  actually  sold,  nor  is  the  tax  imposed  upon 
deliveries  or  transfers  to  a  broker  for  sale,  nor  upon 
the  delivery  or  transfer  of  stock  purchased  by  a  broker, 
to  his  customer.  Such  deliveries  or  transfers,  however, 
must  be  accompanied  by  a  certificate  setting  forth  the 
facts.  Of  course,  at  the  time  a  broker  sells  the  stock  he 
has  received  from  his  customer,  a  tax  must  be  paid. 
This  may  be  paid  by  the  broker,  who  later  charges  his 
customer  with  the  amount  of  the  tax. 

Where  stock  is  transferred  on  the  books  of  the  com- 
pany, the  stamps  must  be  placed  upon  the  books.  Where 
transfer  is  merely  by  delivery  of  the  certificate,  the 
stamp  must  be  placed  upon  the  certificate  itself. 

In  case  of  agreement  to  sell,  as  well  as  in  the  case  of 
transfer  by  assignment  in  blank,  the  seller  must  make 
and  deliver  to  the  buyer  a  memorandum  or  bill  of  sale 
or  agreement  to  sell,  to  which  the  stamps  must  be  affixed, 
and  such  bill  or  agreement  must  show  the  date  thereof, 
the  name  of  the  seller,  the  amount  of  the  sale  and  the 
matter  or  thing  to  which  it  refers. 

Where  title  passed  in  the  transfer  of  stock  prior  to 


528  INCOME   AND    FEDERAL    TAX    REPORTS 

December  1,  1917,  no  tax  accrues,  even  though  the  actual 
physical  transfer  of  the  stock  certificates  was  not  made 
to  the  transferee  or  on  the  books  of  the  corporation  until 
after  that  date. 

In  cases  where  A  owns  a  certificate  of  100  shares  of 
stock  and  transfers  50  shares  of  this  stock  to  B,  and 
there  are  two  certificates  of  50  shares  each  issued  in  lieu 
of  the  100-share  certificate,  50  shares  going  to  A  and 
50  shares  going  to  B,  the  tax  is  imposed  only  upon  the 
transfer  of  the  50  shares  to  B,  there  being  no  tax  on 
A's  transfer  to  himself. 

The  procedure  in  the  collection  of  stamp  taxes  on 
sales  and  transfers  of  shares  of  stock  and  like  securities 
is  given  in  detail  in  Part  I  of  Eegulations  40,  reprinted 
herewith,  explanatory  subject-captions  being  inserted 
for  the  convenience  of  the  reader. 


TREASURY  DEPARTMENT  REGULATIONS  No.   40 

PART  I 

Regulations  Promulgated  by  the  Commissioner  of  Internal 

Revenue,  with  the  Approval  of  the  Secretary  of  the 

Treasury,  for  Collection  of  Stamp  Taxes  on 

Sales  and  Transfers  of  Shares  of 

Stock  and  Like  Securities 


Definitions 


Sales  and  transfers. — Article  1.  That  for  the  purpose 
of  these  regulations,  the  term  "sales  or  transfers"  shall 
be  held  to  include  all  sales,  agreements  to  sell,  memo- 
randa of  sales,  and  all  deliveries  or  transfers  of  legal 
title,  except  as  otherwise  specifically  provided  in  these 
regulations. 

Person. — That  the  word  "person"  or  "every  person" 
or  similar  term  whenever  used  in  these  regulations  shall 


WAR    STAMP    TAXES  529 

include  the  plural  as  well  as  the  singular,  and  shall  be 
taken  to  refer  to  individuals,  partnerships,  associations, 
and  corporations,  except  where  it  is  plain  from  the  con- 
text that  a  different  meaning  is  intended. 

Exchange. — That  wherever  the  word  "exchange"  is 
used  in  these  regulations,  except  as  otherwise  specifically 
indicated,  it  shall  be  deemed  and  taken  to  include  each 
and  every  agent  or  agency,  auction  place  or  other  meet- 
ing place  at  which  stocks  are  publicly  bought,  sold,  bid 
for,  offered,  or  exchanged,  either  between  the  members 
or  patrons  of  such  exchange,  or  as  between  members 
and  nonmembers,  patrons  and  the  public,  and  it  shall 
include  all  incorporated  and  unincorporated  associations 
of  individuals,  partnerships,  and  corporations  engaged 
in  the  business  of  publicly  selling,  buying,  or  exchanging 
shares  of  stock  or  interests  therein. 

Shares  of  stock. — The  term  "share  or  shares  of  stock," 
when  used  in  these  regulations,  except  as  otherwise 
therein  specifically  defined,  shall  be  held  and  taken  to 
mean  and  include  the  shares  and  certificates  for  shares 
of  stock  representing  interests  in  corporations,  and  in 
incorporated  and  unincorporated  associations,  as  well  as 
voting  trust  certificates  for  shares,  and  certificates  for 
shares  or  interests  in  shares,  "if,  as,  and  when  issued," 
and  for  "rights"  therein. 

Clearing  house. — The  terms  "clearing  house,"  "clear- 
ing house  corporation,"  and  "clearing  house  associa- 
tion," shall  be  held  and  taken  to  mean  and  include  each 
and  every  incorporated  and  unincorporated  association 
of  individuals,  partnerships,  and  corporations  wholly  or 
partly  engaged  in  the  business  of  clearing,  settling,  or 
adjusting  transactions  in  the  purchase,  sale,  receipt,  or 
delivery  of  shares  of  stock,  whether  or  not  the  same  be 
a  part  or  department  of  an  exchange  or  an  independent 
body. 

Responsibility  for  compliance  with  tax  provisions. — 
The  act,  omission,  or  failure  of  any  official,  agent,  or 


530  INCOME   AND    FEDERAL    TAX   REPORTS 

other  person  acting  for  or  employed  by  any  association, 
partnership,  or  corporation  within  the  scope  of  his  em- 
ployment or  office,  shall,  in  every  case,  also  be  deemed 
the  act,  omission,  or  failure  of  such  association,  part- 
nership, or  corporation,  as  well  as  that  of  the  person  or 
persons. 

Registration 

Who  must  register. — Art.  2.  Every  person,  partner- 
ship, corporation,  exchange,  or  clearing  house  engaged 
in  whole  or  in  part  in  negotiating,  making,  or  recording 
sales,  agreements  to  sell,  deliveries  or  transfers  of  shares 
or  certificates  for  shares  of  stock,  or  in  conducting  or 
transacting  a  stock-brokerage  business,  or  in  the  clear- 
ing, settling,  or  adjusting  of  any  of  the  transactions  re- 
ferred to  in  section  807,  subdivision  4,  of  the  act,  or  who 
shall  be  engaged  in  the  business  of  accepting  or  procur- 
ing the  transmission  of  orders  for  the  sale  or  purchase 
or  transfers  of  stock  to  be  made  or  executed  at  or  under 
the  rules  or  customs  of  an  exchange  in  the  continental 
United  States,  shall, 

Time  of  registration. — On  the  first  day  of  December, 
1917 — and  if  not  on  that  date  engaged  in  business,  then 
within  ten  days  after  engaging  in  business,  and  on  the 
first  day  of  July  annually  thereafter — 
Place  of  registry. — File  in  the  office  of  the  collector  of 
internal  revenue  of  the  district  in  which  each  place  of 
business  of  such  person,  partnership,  corporation,  ex- 
change, or  clearing  house  is  located,  or  with  such  other 
internal-revenue  officer  as  may  be  hereafter  designated, 
Contents  of  registration  statement. — A  statement,  under 
oath,  setting  forth  the  full  name  or  names  of  such  per- 
son or  persons,  and  of  all  the  members  of  such  partner- 
ship conducting  or  transacting  the  business,  with  the 
post-office  address  or  addresses  of  such  person  or  per- 
sons, or  partnership,  unless  the  person  so  certifying  be 
a  corporation,  exchange,  or  clearing  house,  in  which 


WAR    STAMP    TAXES  531 

event  it  shall  set  forth  its  principal  office  or  place  of 
business,  with  the  names  and  addresses  of  its  chief  offi- 
cer, its  secretary,  accompanied  by  a  list  of  its  members 
and  their  addresses,  and  if  incorporated,  when  and 
where  incorporated,  and  if  not  incorporated,  under  what 
agreement  or  authority  it  is  conducting  such  business  or 
agency.  Such  statement  shall  also  specifically  set  forth 
the  character  of  the  business  to  be  conducted, 
Signatures  required. — And  shall  be  executed  and  duly 
acknowledged  by  the  person  or  persons  so  conducting  or 
intending  to  conduct  said  business,  or  by  the  president 
or  secretary  of  the  corporation  or  exchange  or  clearing 
house. 

Constitution  and  by-laws. — Each  exchange  or  clearing 
house  shall  also  file  with  said  collector  or  other  desig- 
nated internal-revenue  officer  a  copy  of  its  constitution, 
charter,  agreement  of  association,  by-laws,  rules  and 
regulations,  and  of  all  amendments  thereto,  as  the  same 
may  from  time  to  time  be  adopted, 
New  members. — And  the  names  and  addresses  of  new 
members  as  from  time  to  time  admitted  to  membership. 
Licenses. — The  said  statement  shall  further  contain 
information  as  to  whether  the  person  executing  the  same 
has  been  licensed  under  any  State  laws  or  under  any 
other  provision  of  Federal  law ;  and  if  so,  the  dates  and 
places  at  which  any  such  licenses  were  issued. 
Official  form  supplied  by  collector. — Such  statements 
shall  be  made  upon  forms  to  be  furnished  upon  applica- 
tion to  the  collector  of  internal  revenue. 

Record  of  Registration  Kept  by  Collector 

Records  preserved  by  collector. — Art.  3.  Every  col- 
lector or  other  designated  internal-revenue  officer  shall 
file  and  preserve  each  statement  of  registration  made  to 
him  in  accordance  with  these  regulations, 
Certificate  of  registry  issued  by  collector. — And  shall 
issue   to   such  person,  partnership,   exchange,   clearing 


532  INCOME   AND    FEDERAL    TAX    REPORTS 

house,  or  corporation  a  certificate  of  registry,  showing 
the  date  of  issue,  the  name  of  the  person  or  persons,  or 
exchange,  clearing  house,  or  corporation,  conducting  the 
business,  the  nature  of  the  business  for  which  the  license 
is  granted,  and  the  date  of  expiration  of  said  registry, 
which  certificate  shall  be  signed  by  the  collector  or  other 
designated  internal-revenue  officer, 

Certificate  to  be  posted  in  place  of  business. — And  shall 
be  posted  in  some  prominent  place  in  the  office  of  said 
person,  partnership,  exchange,  clearing  house,  or  corpo- 
ration during  the  period  for  which  issued.  If  such  busi- 
ness is  conducted  at  more  than  one  place,  a  certificate 
shall  be  so  posted  in  each  such  place  of  business. 

Rate  of  Taxation 

Tax  on  transfer  of  stock  with  face  value. — Art.  4.  In 
the  case  of  shares  or  certificates  of  stock  having  a  face 
(or  par)  value,  the  amount  of  the  tax  shall  be  based  upon 
the  total  face  value  of  the  shares  involved  in  any  sale 
or  agreement  to  sell  or  memorandum  of  sale,  delivery, 
or  transfer,  and  shall  be  at  the  rate  of  2  cents  for  each 
$100  of  such  total  face  value  or  fraction  thereof,  whether 
such  aggregate  face  value  is  greater  or  less  than  $100. 
Thus  where  the  total  face  value  of  the  shares  or  certifi- 
cates of  stock,  agreement  to  sell,  or  memorandum  of  sale 
involved  in  any  such  transaction  is  less  than  $100,  the 
amount  of  such  tax  shall  be  2  cents ;  where  the  total  face 
value  exceeds  $100  but  is  $200  or  less,  the  amount  of 
such  tax  shall  be  4  cents; 

Non-par  stock. — And  where  such  shares  of  stock  are 
without  face  (or  par)  value,  the  tax  shall  be  2  cents  on 
the  transfer  or  sale  or  agreement  to  sell  on  each  share, 
unless  the  actual  value  thereof  is  in  excess  of  $100  per 
share,  in  which  case  the  tax  shall  be  2  cents  on  each  $100 
of  actual  value  or  fraction  thereof. 


WAR    STAMP    TAXES  533 

Transactions  Not  Taxable 

No  tax  on  deposit  of  stock  as  collateral. — Art.  5.  No 
tax  is  imposed  upon  an  agreement  evidencing  a  deposit 
of  stock  certificates  as  collateral  security  for  money 
loaned  thereon,  which  stock  certificates  are  not  actually 
sold  or  intended  to  be  sold  nor  as  to  which  there  is  no 
change  of  ownership  or  interest  nor  upon  such  stock  cer- 
tificates so  deposited. 

No  tax  on  transfer  to  or  by  a  broker. — Nor  upon  de- 
liveries or  transfer  to  a  broker  for  sale,  nor  upon  deliv- 
eries or  transfers  by  a  broker  to  a  customer  for  whom 
and  upon  whose  order  he  has  purchased  the  same, 
Certificate  to  be  signed  by  broker. — Provided  such  deliv- 
eries or  transfers  shall  be  accompanied  in  each  case  by 
a  certificate  setting  forth  the  facts,  such  certificates  to 
be  substantially  in  the  following  form: 

(a)  (In  the  case  of  a  transfer  to  a  broker) — 

"We  hereby  certify  that  we  have  no  ownership,  or  in- 
terest, in  *  *  *  shares  of  the  stock  above  transferred, 
the  transfer  by  the  owner  to  us  being  merely  for  the  pur- 
pose of  sale." 

(b)  (In  the  case  of  a  transfer  by  a  broker) — 

"We  hereby  certify  that  the  transfer  of  *  *  *  of  the 
within  shares  to  the  names  indicated  by  the  star  is  made 
solely  to  complete  the  purchase  made  by  us  for  our  cus- 
tomer, and  we  have  no  ownership  or  interest  therein." 

No  broker  who  has  filed  a  certificate  under  the  fore- 
going clause  (a)  of  this  ruling  shall  file  a  certificate 
under  the  foregoing  clause  (b)  with  reference  to  the 
transfer  of  any  shares  of  stock  covered  by  the  certifi- 
cate filed  by  him  under  clause  (a). 

No  tax  on  clearing  house  adjustments. — Nor  upon 
transfers  or  deliveries  to  a  clearing  house  for  the  sole 
purpose  of  clearing  or  adjusting  accounts  between  mem- 
bers, where  no  beneficial  interest  is  vested  in  said  clear- 
ing house  or  clearing  association  and  there  has  been  no 
change  of  title  or  interest:  Provided, 


534  INCOME   AND    FEDERAL    TAX    REPORTS 

Transactions  of  members  to  be  reported  to  clearing 
house. — The  exchange  shall  by  appropriate  by-laws  or 
regulations  require  from  its  members  that  all  transac- 
tions of  such  members  in  shares  of  stock  be  promptly 
reported  to  such  clearing  house  to  the  end  that  the  stamp 
taxes  thereon  may  be  collected  and  that  no  other  clear- 
ances or  settlements  or  trading  in  balances  shall  be  per- 
mitted. All  transactions,  actual  or  otherwise,  except  as 
in  the  act  are  exempt,  shall  be  subject  to  the  tax. 

Administrative  provision. — No  provision,  by-law,  rule, 
or  custom  of  any  exchange,  or  similar  institution,  incon- 
sistent with  any  requirement  or  provision  of  the  act  or 
any  regulations  thereunder,  nor  any  collateral  or  addi- 
tional agreement  or  understanding,  either  verbal  or  writ- 
ten, respecting  the  subject  matter  of  such  sales  or  trans- 
fers, or  the  settlement  or  fulfillment  thereof,  which  is  in- 
consistent or  in  conflict  with  any  requirement  of  said 
act  or  of  these  regulations,  shall  exempt  any  person 
from  the  payment  of  the  tax  provided  for  under  said  act. 

Delivery  of  Memorandum  of  Sales 

Each  taxable  transaction  must  include  memorandum. 
— Art.  6.  Every  person  who  makes  sales,  or  agreements 
to  sell,  or  memoranda  of  sales  or  deliveries  of,  or  trans- 
fers of  the  legal  or  beneficial  title  to  shares  of  stock,  at, 
in  or  on  any  exchange  or  similar  place  of  business,  and 
every  person  who  makes  any  agreement  to  sell  stock  or 
makes  a  transfer  of  stock  by  delivery  of  the  certificate 
therefor  assigned  in  blank,  shall  as  a  part  of  every  such 
transaction,  promptly  make  and  deliver  to  the  buyer  a 
bill,  or  memorandum  of  sale,  or  agreement  to  sell, 
Signatures. — Duly  signed  by  the  principal  or  his  agent, 
Contents. — Which  shall  show  the  date  of  the  transaction 
evidenced  by  it,  the  names  of  the  seller  and  buyer,  the 
shares  of  stock  to  which  it  relates,  the  number  of  shares 
and  the  price  per  share  of  said  stock, 


WAR    STAMP    TAXES  535 

Each  memorandum  to  be  numbered. — And  shall  bear  a 
number  upon  the  face  thereof. 

Separate  number  for  each  memorandum. — No  more  than 
one  such  bill  or  memorandum  made  by  the  seller  on  any 
given  day  shall  bear  the  same  number:  Provided,  how- 
ever, 

One  stamped  memorandum  for  each  transaction, — That 
no  single  transaction  of  a  purchase  or  sale  that  is  made 
upon  an  exchange  by  one  member  for  another  member 
shall  require  to  be  evidenced  by  more  than  one  stamped 
memorandum  of  sale  or  agreement  to  sell. 

Affixing  and  Cancellation  of  Stamps 

Transfer  by  assignment  in  blank. — Art.  7.  In  case  the 
transfer  is  effected  by  delivery  of  the  certificate  of  stock 
assigned  in  blank  the  stamp  shall  be  affixed  to  the  bill, 
memorandum,  or  agreement  to  sell. 

Transfer  by  delivery  of  certificate. — In  case  the 
change  of  ownership  is  by  transfer  of  the  certificate  of 
stock,  the  stamp  shall  be  affixed  to  the  certificate,  and  in 
no  event  shall  any  company  or  registrar  or  transfer 
agent  accept  or  transfer  any  shares  of  stock  or  certifi- 
cates therefor  unless  stamps  for  all  transfer  tax  required 
to  be  affixed  to  the  certificate  are  attached  thereto  prop- 
erly canceled. 

Transfer  on  company's  books. — In  case  the  evidence 
of  the  transfer  is  shown  only  by  the  books  of  the  com- 
pany the  stamp  shall  be  placed  upon  the  books. 

Agreement. — In  all  other  cases  the  payment  shall  be 
evidenced  by  affixing  the  stamp  upon  the  memorandum 
or  agreement  of  sale  to  be  delivered  by  the  seller  to  the 
buyer. 

Method  of  cancellation. — The  person  using  or  affixing 
a  stamp  shall  write  or  stamp  thereon,  in  ink,  his  initials 
and  the  day,  month,  and  year  on  which  the  same  shall 
be  used  or  affixed,  or  shall  by  cutting  or  cancelling  said 
stamp  with  a  machine  or  punch  affixing  his  initials  and 


536  INCOME   AND    FEDERAL    TAX   REPORTS 

date  as  aforesaid,  so  deface  the  stamp  as  to  render  it 
unfit  for  reuse.  In  addition  to  the  foregoing,  stamps  of 
the  value  of  10  cents  or  more  shall  have  three  parallel 
incisions  made  by  some  sharp  instrument  lengthwise 
through  the  stamp  after  the  same  has  been  attached  to 
the  bill,  memorandum,  or  other  evidence  of  sale  or  trans- 
fer of  stock,  provided  this  will  not  be  required  where 
stamps  are  canceled  by  perforation.  The  cancellation 
by  either  method  should  not  so  deface  the  stamp  as  to 
prevent  its  denomination  and  genuineness  from  being 
readily  determined. 

Records  of  Sales  or  Transfers  of  Stock 

Transactions  to  be  recorded. — Art.  8.  All  persons  who 
are  wholly  or  partly  engaged  in  the  business  of  buying, 
selling,  or  transferring  shares  of  stock,  whether  at  pub- 
lic or  private  sale,  or  whether  or  not  they  are  members 
of  an  exchange,  including  persons  engaged  in  transac- 
tions known  as  "matched,"  or  "on-order,"  or  "pass- 
outs,"  or  by  any  other  name  or  term  at,  on,  or  in  any 
exchange  or  similar  place,  whether  or  not  such  trans- 
actions are  cleared,  adjusted,  or  settled  through  a  clear- 
ing house  or  directly  between  seller  and  buyer,  or  other- 
wise, 
Contents  of  record. — Shall  keep  a  record  showing — 

(a)  The  date  of  the  transaction. 

(b)  The  name  of  the  seller  or  transferror. 

(c)  The  name  of  the  purchaser  or  transferee. 

(d)  If  the  order  was  executed  on  an  exchange,  the 

name  of  the  person  who  executed  the  order. 

(e)  Whether  the  transaction  is  a  purchase  or  sale. 

(f)  The  name  of  the  corporation  the  stock  of  which 

is  the  subject  of  the  sale  and  the  number  of 
shares  thereof. 

(g)  Whether  the  stock  was  listed  on  an  exchange, 
(h)  Whether  the  stock  was  cleared  through  a  clearing 

house. 


WAR    STAMP   TAXES  537 

(i)  The  face  or  par  value  of  the  stock. 

(j)  The  price  of  the  stock  if  there  is  no  face  or  par 

value, 
(k)  Whether  the  shares  were  borrowed  or  loaned. 
(1)  Whether    the    transaction    was    "matched,"    "on- 
order,"  a  "pass-out,"  or  a  "scratched  sale,"  or 
any  other  kind  of  sale  or  purchase, 
(m)  The  amount  of  tax  paid. 

(n)  The  identifying  number  of  the  bill  or  memoran- 
dum of  sale,  as  required  by  article  6  of  these 
regulations, 
(o)  The  origin  of  the  order,  whether  domestic  (refer- 
ring to  the  Continental  United  States),  or  for- 
eign (referring  to  other  countries). 
Records  to  be  in  book  form  and  kept  two  years. — Per- 
sons using  such  forms  may  incorporate  therein  addi- 
tional columns  that  would  be  of  use  to  them,  such  col- 
umns to  be  placed  after  the  columns  containing  the  infor- 
mation herein  required,  so  as  not  to  interfere  with  the 
columns  and  headings  hereby  prescribed.    These  records 
must  be  in  book  form,  and  all  entries  therein  must  be 
legibly  written  in  ink  and  the  records  kept  for  a  period 
of  at  least  two  years.     Such  record  forms  will  not  be 
supplied  by  the  department. 

Prescribed  form  of  record. — The  form  of  record  re- 
quired shall  be  as  follows: 

Returns  by  Persons  Making  Sales 
Who  makes  return. — Art.  9.  All  persons  who  are 
wholly  or  partly  engaged  in  the  business  of  buying,  sell- 
ing, or  transferring  shares  of  stock  at,  in,  or  on  an  ex- 
change, whether  or  not  such  sales,  purchases,  or  trans- 
fers shall  be  made,  cleared,  settled,  or  adjusted  through 
a  clearing  house ;  shall 

Time  and  place  of  filing  return. — On  or  before  the  fif- 
teenth day  of  each  month,  and  at  any  other  time  or  times 
-that  may  be  designated  by  the  Commissioner  of  Internal 


538  INCOME   AND    FEDERAL    TAX    REPORTS 

Revenue,  render  under  oath  a  true  return  of  all  such 
sales  and  purchases  to  said  commissioner  for  the  pre- 
ceding month  or  for  any  other  period  designated  by  the 
commissioner, 

Contents  of  return. — Containing  in  detail  the  following 
data  and  information: 

(a)  The  month  for  which  the  return  is  made. 

(b)  The  name  and  address  of  the  person,  partner- 

ship, corporation,  or  association  making  the  re- 
turn. 

(c)  The  number  of  shares  of  stock  sold   and  pur- 

chased on  such  exchange  and  cleared  by  its 
clearing  agency  or  association. 

(d)  The  number  of  shares  of  stock  sold  and  pur- 

chased on  such  exchange  that  were  not  cleared 
by  its  clearing  agency  or  association. 

(e)  In  respect  of  shares  having  a  face  (or  par)  value: 

(1)  The  aggregate  face  value  of  all  shares,  not 

including  any  fraction  of  less  than  $100 
of  face  value  involved  in  any  transaction. 

(2)  The  number  of  fractions  of  less  than  $100 

of  face  value  involved  in  all  transactions. 

(f)  In  respect  of  shares  having  no  face    (or  par) 

value : 

(1)  As  to  such  shares  of  an  actual  value  in  ex- 

cess of  $100  per  share — 

(A)  The  aggregate  actual  value  of  all 

shares,  not  including  any  frac- 
tion of  less  than  $100  involved 
in  any  transaction. 

(B)  The  number  of  fractions  of  less 

than  $100  involved  in  all  trans- 
actions in  such  shares. 

(2)  As  to  such  shares  of  an  actual  value  of  $100 

or  less  per  share — 

(A)  The  total  number  of  such  shares. 


WAR   STAMP   TAXES  539 

(g)  As  to  shares  purchased,  the  same  information  and 
detail  required  for  shares  sold,  transferred,  and 
delivered  required  under  (e)  and  (f)  for  shares 
sold,  transferred,  or  delivered, 
(h)  The  number  of  shares  of  stock  borrowed, 
(i)    The  number  of  shares  of  stock  loaned, 
(j)   The  number  of  shares  of  loaned  stock  returned, 
(k)  The  number  of  shares  of  borrowed  stock  returned. 
(1)    The  amount  of  tax  paid. 

(m)  The  amount  in  dollars  of  stamps  purchased  dur- 
ing the  month, 
(n)  The  amount  in  dollars  of  stamps  on  hand  on  the 
last  day  of  the  month  for  which  return  is  being 
made. 
Forms  furnished. — Such  returns  shall  be  made  upon 
forms  furnished  upon  application  by  the  internal  reve- 
nue collector  or  other  designated  officer. 

Commissioner  may  require  returns  for  any  trans- 
actions.— The  Commissioner  of  Internal  Eevenue  may, 
from  time  to  time,  require  any  person  wholly  or  partly 
engaged  in  the  business  of  buying,  selling,  or  transfer- 
ring shares  of  stock,  whether  at  public  or  private  sale, 
and  whether  or  not  such  sale  shall  be  made  on  an  ex- 
change or  cleared,  settled,  or  adjusted  through  a  clear- 
ing house  to  render  under  oath  returns  of  all  such  trans- 
actions upon  forms  prescribed  by  him. 

Returns  by  Clearing  Houses 

Clearing  house  to  file  return. — Art.  10.  Every  clear- 
ing house  or  committee  or  body  through  or  by  which 
clearing  is  done  shall, 

Time  of  filing. — On  or  before  the  fifteenth  day  of  each 
month,  and  at  any  other  time  designated  by  the  Com- 
missioner of  Internal  Eevenue,  render  in  writing  under 
oath  to  the  Commissioner  of  Internal  Eevenue  a  return 
for  the  preceding  month,  or  for  any  other  period  that 
may  be  designated  by  the  Commissioner, 


540  INCOME    AND    FEDERAL    TAX    REPORTS 

Contents  of  return. — Of  all  facts  in  their  possession 
relating  to  any  and  all  such  transactions,  and  showing 
in  detail: 

(a)  The  month  for  which  return  is  made; 

(b)  The  name  and  address  of  the  clearing  house  or 

similar  business,  agency,  or  institution  making 
the  return;  and 

(c)  The  number  of  shares  of  stock  directed  to  be  re- 

ceived and  the  number  of  shares  of  stock  di- 
rected to  be  delivered  and  cleared,  settled,  or 
adjusted  for  each  member  during  the  month  or 
period  for  which  the  return  is  made. 

Forms. — Such  return  shall  be  made  upon  the  forms  to 
be  furnished  upon  application  by  the  collector  of  internal 
revenue  or  other  designated  officer. 

Member's  daily  written  report  to  clearing  house 
deemed  to  be  the  taxable  memorandum. — If  any  person 
who  negotiates  sales  or  transfers  of  stock  on  a  stock 
exchange,  shall  appoint  in  writing  the  clearing  house  for 
such  exchange  upon  which  such  sale  or  transfers  are 
made,  if  any,  his  agent  for  the  purposes  hereinafter  in- 
dicated, such  clearing  house  being  approved  by  the  Com- 
missioner of  Internal  Revenue,  and  shall  make  a  written 
return,  statement  or  sheet,  to  such  clearing  house  con- 
taining a  full  disclosure  on  each  business  day  of  all  such 
transactions,  both  such  as  are  clearable  and  non-clear- 
able,  of  the  preceding  day  in  shares  of  stock  that  are 
listed  or  permitted  to  be  dealt  in  by  such  member  on 
such  exchange,  also  which  if  any  of  such  stocks  are 
loaned  or  borrowed,  then  in  that  event  such  return, 
statement,  or  sheet  delivered  to  the  clearing  house  shall 
be  deemed  to  be  the  bill,  or  memorandum  of  sale,  or 
agreement  to  sell,  required  under  section  807,  subdivi- 
sion 4,  of  the  act  approved  October  3,  1917, 
Clearing  house  may  affix  and  cancel  stamps  as  member's 
agent. — And  such  clearing  house  is  hereby  authorized  to 


WAR    STAMP    TAXES  541 

affix  to  such  return,  statement,  or  sheet  the  amount  of 
stamps  required  for  each  sale  or  agreement  to  sell  or 
memorandum  of  sale  for  delivery  or  transfer  of  such 
stock  indicated  thereon,  and  to  cancel  the  stamp  so  af- 
fixed. The  affixing  and  cancellation  of  such  stamps  by 
the  clearing  house  shall  be  held  to  be  that  of  the  person 
making  such  sale  or  agreement  to  sell,  or  memorandum 
of  sale,  for  delivery  or  transfer  of  such  stock. 
Contents  of  member's  memorandum  report  to  clearing 
house. — The  returns,  statements,  or  sheets  made  to  the 
clearing  house  shall  in  respect  of  each  sale  show  the  date 
thereof,  the  name  of  the  seller,  the  name  of  the  buyer, 
the  amount  of  the  sale,  and  the  name  of  the  stock,  cer- 
tificates, voting  shares,  or  other  things  traded  in,  but  a 
return  for  more  than  one  sale  may  be  upon  the  same 
return,  statement,  or  sheet, 

Transactions  must  be  fully  disclosed. — And  no  settle- 
ment of  differences  or  other  dealings  between  members 
shall  be  permitted  that  will  interfere  with  the  full  dis- 
closure of  the  whole  transaction. 

Tax  paid  sheets  to  be  kept  two  years. — Said  clearing 
house  shall  preserve  the  returns,  statements,  or  sheets 
so  made  and  stamped  for  at  least  two  years. 

Monthly  return  to  be  made  by  seller  to  Commissioner 
of  Internal  Revenue. — But  such  return,  statement,  or 
sheet  to  the  clearing  house  shall  not  relieve  the  person 
from  making  the  monthly  return  required  by  these  regu- 
lations. 

Clearing  house  must  keep  records  of  transfers  of  cus- 
tomers' accounts. — Wherever  any  clearing  house  associa- 
tion or  similar  body  carries  upon  its  sheets  or  records 
information  or  reports  of  transactions  showing  the 
transfer  by  one  of  its  members  of  an  account  of  a  cus- 
tomer without  change  of  ownership  of  the  securities  of 
the  customer,  there  shall  be  kept  by  the  members  of  such 
clearing  house  or  body  concerned  in  such  transaction, 
a  record  showing  the  particulars  of  such  transaction. 


542  INCOME   AND    FEDERAL    TAX    REPORTS 

Substitute  Returns — Agents 

In  default  of  return,  internal  revenue  officer  may  in- 
spect books  and  make  return. — Art.  11.  If  any  person  or 
clearing  house  required  to  make  any  return  by  law,  or 
the  regulations  thereunder,  shall  fail  or  refuse  to  make 
such  return  within  the  time  prescribed,  such  return  may 
be  made  by  an  internal  revenue  officer,  upon  inspection 
of  the  books  and  papers  of  the  person  or  clearing  house 
required  to  make  such  returns;  but  the  making  of  such 
return  by  an  internal  revenue  officer  shall  not  relieve  the 
person  or  clearing  house  in  default  from  any  penalty  in- 
curred by  reason  of  the  failure  to  make  such  return. 

Authority  of  commissioner  or  agent. — Any  officer  des- 
ignated by  the  Commissioner  of  Internal  Eevenue  shall 
have  authority  to  examine  the  books,  papers,  and  records 
kept  pursuant  to  these  regulations  and  may  require  the 
production  of  any  other  books,  records,  papers,  or  state- 
ments of  account,  necessary  to  determine  any  liability 
to  the  tax  imposed  by  the  act,  or  to  the  observance  of 
the  provisions  of  the  regulations  made  in  accordance 
therewith. 

Sale  of  Stamps 

Who  may  sell  stamps. — Art.  12.  No  person  other  than 
a  collector  of  internal  revenue,  or  duly  authorized  dep- 
uty collector  of  internal  revenue,  an  Assistant  Treas- 
urer, or  other  United  States  designated  depositary  shall 
sell  or  expose  for  sale,  give  away,  traffic  in,  trade,  bar- 
ter,  lend,  borrow,  or  exchange  any  stamp,  issued  pursu- 
ant to  these  regulations.  No  person  shall  buy  or  receive 
any  such  stamps  or  have  the  same  in  his  possession  or 
under  his  control,  unless  such  stamps  have  been  pur- 
chased directly  from  the  collector  of  internal  revenue, 
Assistant  Treasurer,  or  other  United  States  designated 
depositary,  in  the  district  in  which  the  stamps  are  to 
be  used. 


WAR   STAMP   TAXES  543 

Requisitions  for  stamps. — All  requisitions  for  stamps 
to  be  used  under  these  regulations  shall  be  made  in  writ- 
ing, in  ink,  on  a  form  prescribed  by  the  Commissioner 
of  Internal  Eevenue,  to  the  collector  of  internal  revenue, 
or  to  an  Assistant  Treasurer,  or  other  designated  de- 
positary, in  the  internal-revenue  district  in  which  the 
stamps  are  to  be  used,  giving  the  date  thereof,  the  num- 
ber and  denomination  of  stamps  applied  for,  and  the 
name  and  address  of  the  purchaser,  and  shall  be  signed 
in  ink  by  the  person  receiving  the  stamps. 

Record  of  requisitions  to  be  kept  by  collector. — The 
collector  of  internal  revenue  to  whom  such  requests  are 
made  shall  keep  a  record  thereof,  and  shall  keep  the 
requisitions  separate  and  apart  from  all  other  requisi- 
tions for  stamps,  and  preserve  them  in  his  office  for  a 
period  of  two  years.  Any  Assistant  Treasurer  or  desig- 
nated depositary  of  the  United  States  receiving  requi- 
sitions for  such  stamps  shall  keep  a  record  of  each  such 
requisition  and  at  the  end  of  each  month  shall  file  such 
requisitions  with  his  monthly  report  to  the  collector  of 
internal  revenue  of  the  district  in  which  said  Assistant 
Treasurer  or  other  designated  depositary  is  located. 

Kinds  of  stamps. — The  stamps  to  be  used  under  these 
regulations  shall  be  of  such  kind  and  color  as  are  pre- 
scribed by  the  Commissioner  of  Internal  Eevenue. 

Note 

Administrative  provisions. — For  the  provisions  as  to 
fines  and  penalties  applying  particularly  to  violations  or 
attempted  evasions  of  the  act  or  of  these  regulations, 
reference  is  made  to  sections  802,  803,  807,  subdivisions 
4  and  5,  and  1004  of  the  "Act  to  provide  revenue  to  de- 
fray war  expenses  and  for  other  purposes,"  approved 
October  3,  1917.  The  provisions  of  the  internal-revenue 
laws  of  the  United  States,  so  far  as  applicable,  including 
sections  3173,  3174  and  3175,  of  the  Eevised  Statutes, 
as  amended,  apply  to  said  act. 


544  INCOME   AND    FEDERAL    TAX    REPORTS 

Sales  of  products  or  merchandise  on  exchange  for  future 
delivery. — A  tax  of  2  cents  for  each  $100  in  value  is  im- 
posed upon  all  sales  of  produce  or  merchandise  on  ex- 
changes or  boards  of  trade  for  future  delivery.  Cash 
sales,  for  immediate  or  prompt  delivery  of  products  or 
merchandise  actually  intended  to  be  delivered,  are  not 
subject  to  the  tax.  Agreements  to  sell,  including  so- 
called  transferred  or  "scratch  sales,"  are  likewise  tax- 
able, substantially  as  provided  in  the  case  of  agree- 
ments, etc.,  relating  to  the  sale  of  stock,  as  enumerated 
hereinbefore. 

It  is  provided  that  sellers  of  commodities  who  have 
duly  paid  the  tax  may  transfer  their  contracts  to  a  clear- 
ing house  for  the  adjustment  and  balancing  of  the  ac- 
counts of  the  members  of  the  clearing  house  association 
on  their  several  contracts  and  that  such  transfer  will 
not  be  taxable,  provided,  however,  that  the  transfer  in- 
vests no  beneficial  interest  in  the  clearing  house  asso- 
ciation. 

The  following  are  the  Treasury  Department  Kegula- 
tions  relating  to  the  stamp  tax  upon  sales  of  products 
or  merchandise  on  exchanges  for  future  delivery. 


TREASURY  DEPARTMENT  REGULATIONS  No.  40 

PART  II 

Regulations  Promulgated  by  the  Commissioner  of  Internal 

Revenue,   with  the  Approval  of  the  Secretary  of  the 

Treasury,  for  the  Collection  of  Stamp  Taxes  Upon 

Sales  of  Products  or  Merchandise  on  Exchanges 

for  Future  Delivery 


Definitions 
Sale. — Art.  1.  That  for  the  purposes  of  these  regula- 
tions the  term  "sale"  or  "contract  of  sale"  shall  be  held 
to  include  all  sales,  or  agreements  of  sale,  or  agreements 
to  sell,  including  so-called  transfers  or  "scratched  sales." 


WAR   STAMP   TAXES  545 

Person. — The  word  "person"  or  "every  person,"  or 
similar  term,  whenever  used  in  these  regulations,  shall 
include  the  plural  as  well  as  the  singular,  and  shall  be 
taken  to  refer  to  individuals,  partnerships,  associations, 
and  corporations,  except  where  it  is  plain  from  the  con- 
text that  a  different  meaning  is  intended. 

Exchange. — The  word  "exchange"  as  used  in  these 
regulations,  except  as  otherwise  specifically  indicated  in 
the  regulations,  shall  be  deemed  and  taken  to  include 
each  and  every  agent  or  agency,  auction  place,  or  other 
meeting  place  at  which  produce  or  merchandise  for  fu- 
ture delivery  is  publicly  bought,  sold,  bid  for,  offered,  or 
exchanged,  or  contracts  for  such  future  delivery  are 
made,  either  between  the  members  or  patrons  of  such 
exchange,  or  as  between  members  and  nonmembers, 
patrons,  and  the  public,  and  it  shall  include  all  incor- 
porated and  unincorporated  associations  of  individuals, 
partnerships,  and  corporations  engaged  in  the  business 
of  publicly  selling,  buying,  or  exchanging  products  or 
merchandise  for  future  delivery. 

Clearing  house. — The  term  "clearing  house"  shall  be 
held  to  mean  each  and  every  clearing-house  corporation, 
clearing-house  association,  or  incorporated  and  unincor- 
porated association,  carried  on  for  the  purpose  of  clear- 
ing, settling,  and  adjusting  transactions  in  purchasing, 
selling,  receiving,  or  delivering  products  or  merchandise, 
whether  such  clearing  house  be  a  part  or  department 
of  an  exchange  or  an  independent  body. 

Responsibility  for  compliance  with  tax  provisions. — 
The  act,  omission,  or  failure  of  any  official,  agent,  or 
other  person  acting  or  employed  by  any  person,  asso- 
ciation, partnership,  or  corporation,  within  the  scope  of 
his  employment  or  office,  shall  in  every  case  also  be 
deemed  the  act,  omission,  or  failure  of  such  person,  asso- 
ciation, partnership,  or  corporation. 


546  INCOME   AND    FEDERAL    TAX    REPORTS 

Registration 

Who  must  register. — Art.  2.  Every  person  engaged  in 
whole  or  in  part  in  making  contracts  of  sale  of  any  prod- 
uct or  merchandise  or  commodity  at,  on,  or  in,  or  under 
the  rules  or  customs  of  any  exchange  for  future  deliv- 
ery, or  engaged  in  the  business  of  accepting  or  procur- 
ing the  transmission  of  such  contracts  of  sale,  to  be  exe- 
cuted on  any  exchange,  and  every  exchange  and  every 
clearing  house  shall, 

Time  of  registration. — On  the  first  day  of  December, 
1917,  and  if  not  on  that  date  engaged  in  business,  then 
within  ten  days  after  engaging  in  business,  and  on  the 
first  day  of  July  annually  thereafter  file 
Place  of  registration. — In  the  office  of  the  collector  of  in- 
ternal revenue  of  the  district  in  which  each  place  of 
business  of  such  person,  exchange,  or  clearing  house  is 
located,  or  with  such  other  internal-revenue  officer  as 
may  be  hereafter  designated, 

Contents  of  Statement. — A  statement  under  oath  setting 
forth  the  full  name  of  such  person,  if  an  individual,  and 
if  a  partnership  the  full  names  of  all  the  members  of 
such  partnership,  with  the  post-office  address  of  the  in- 
dividual or  partnership;  and  if  the  person  filing  such 
statement  be  a  corporation  or  association  it  shall  set 
forth  its  principal  office  or  place  of  business  with  the 
names  and  addresses  of  its  chief  officer  and  its  secretary, 
accompanied  by  a  list  of  its  members  and  their  ad- 
dresses, and  if  incorporated,  when  and  where  incorpo- 
rated, and  if  unincorporated,  under  what  agreement  or 
authority  it  is  conducting  business,  together  with  a  copy 
of  such  agreement. 

Signatures  required. — Statements  filed  in  behalf  of  any 
corporation,    association,    exchange,    or   clearing  house 
shall  be  executed  and  duly  acknowledged  by  the  presi- 
dent or  secretary  thereof. 
Information  required  of  exchange  or  clearing  house. — 


WAR   STAMP   TAXES  547 

Every  statement  filed  by  an  exchange  or  clearing  house 
shall  specifically  set  forth  the  character  of  the  business 
conducted  or  intended  to  be  conducted.  Each  exchange 
and  clearing  house  shall  also  file  with  the  said  collector 
or  other  designated  internal-revenue  officer  a  copy  of  its 
constitution,  charter,  agreement  of  association,  by-laws, 
and  regulations,  and  all  amendments  thereto,  as  the  same 
may  from  time  to  time  be  adopted,  and  the  names  and 
addresses  of  new  members  as  from  time  to  time  admit- 
ted to  membership. 

Forms. — The  statements  required  by  these  regulations 
shall  be  made  upon  forms  to  be  prescribed  by  the  Com- 
missioner of  Internal  Eevenue. 

Records  and  Certificates 

Records  kept  by  collector. — Art.  3.  Every  collector  of 
internal  revenue  or  other  designated  internal-revenue 
officer  shall  file  and  preserve  each  statement  or  registra- 
tion made  to  him  in  accordance  with  these  regulations, 
Certificate  issued  by  collector. — And  shall  issue  to  the 
person  making  such  statement  a  certificate  of  registry 
showing  the  date  of  issue,  the  name  of  the  person,  the 
nature  of  the  business  for  which  the  certificate  is 
granted,  and  the  date  of  the  expiration  of  the  registra- 
tion, which  certificate  shall  be  signed  by  the  collector  or 
other  designated  internal-revenue  officer, 
Certificate  to  be  posted  in  place  of  business. — And  shall 
at  all  times  during  the  period  for  which  it  is  issued  be 
posted  in  some  prominent  place  in  the  office  of  the  per- 
son receiving  it.  If  the  business  of  such  person  is  con- 
ducted at  more  than  one  place,  a  certificate  shall  be  so 
posted  in  each  such  place  of  business. 

Transactions  Not  Taxable 

Cash  sales  for  prompt  delivery  exempt. — Art.  4.  No 

tax  is  imposed  on  cash  sales  of  products  or  merchandise 

•  for  immediate  or  prompt  delivery  which  in  good  faith 


548  INCOME   AND    FEDERAL    TAX    REPORTS 

are  actually  intended  to  be  delivered.  All  sales  at  an 
exchange  for  future  delivery  are  subject  to  the  payment 
of  the  tax. 

"Delivery"  defined. — For  the  purpose  of  these  regu- 
lations "immediate  or  prompt  delivery"  shall  mean  de- 
livery at  once  or  as  soon  as  practicable,  and  in  any  event 
within  twenty  days  of  the  date  of  the  sale  or  agreement. 
Every  sale  or  agreement  not  evidenced  by  a  memoran- 
dum or  contract  expressly  requiring  immediate  or 
prompt  delivery  within  the  above  definition  shall  be 
deemed  to  be  for  future  delivery.  In  all  cases  in  which 
the  commissioner  is  not  satisfied  from  the  evidence  sub- 
mitted to  him  that  the  transaction  was  in  good  faith  in- 
tended to  be  followed  by  immediate  or  prompt  delivery, 
within  the  above  definition,  the  seller  shall  be  required 
to  pay  the  tax  as  on  a  sale  for  future  delivery. 

Transfer  to  clearing  house. — Sellers  of  products,  mer- 
chandise, or  commodities  having  paid  the  tax  provided 
by  law  may  transfer  such  contracts  to  a  clearing-house 
association,  and  such  transfer  shall  not  be  deemed  to  be 
a  sale,  or  agreement  of  sale,  or  agreement  to  sell,  within 
the  provisions  of  the  act,  provided  that  such  transfer 
does  not  vest  any  beneficial  interest  in  the  clearing  house 
association  and  is  made  for  the  sole  purpose  of  enabling 
such  clearing-house  association  to  adjust  and  balance 
the  accounts  of  the  members  of  said  clearing-house  asso- 
ciation on  their  several  contracts. 

Administrative  provisions.  —  No  provision,  by-law, 
rule,  or  custom  of  any  exchange,  board  of  trade,  or  simi- 
lar institution  or  place  of  business  which  is  inconsistent 
or  in  conflict  with  any  requirement  or  provision  of  the 
"Act  to  provide  revenue  to  defray  war  expenses,  and  for 
other  purposes,"  approved  October  3,  1917,  or  any  regu- 
lations thereunder,  nor  any  collateral,  or  additional 
agreement  or  understanding,  either  verbal  or  written, 
respecting  the  subject  matter  of  such  contract  or  the  set- 
tlement or  fulfillment  thereof,  which  is  inconsistent  or. 


WAR   STAMP   TAXES  549 

in  conflict  with  any  requirement  of  said  act  or  the  regu- 
lations thereunder  promulgated  by  the  Commissioner  of 
Internal  Eevenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  shall  exempt  any  person  from  the  pay- 
ment of  the  tax  provided  for  under  section  807,  subdi- 
vision 5,  of  said  act. 

Memoranda  of  Sales 

Memorandum  to  be  delivered  by  seller  to  buyer. — Art. 
5.  Every  person  who  makes  sales  or  contracts  of  sale 
of  any  product,  merchandise,  or  commodity  at,  on,  or  in 
any  exchange  for  future  delivery,  shall,  except  as  herein 
otherwise  expressly  provided,  deliver  to  the  buyer  a  bill, 
memorandum,  agreement,  or  other  evidence  of  such  sale 
or  agreement  of  sale, 

Contents  of  memorandum. — Which  shall  show  the  date 
thereof,  the  name  of  the  seller,  the  name  of  the  pur- 
chaser, the  product,  merchandise,  or  commodity,  the 
quantity  thereof  to  which  it  refers,  the  price,  the  aggre- 
gate amount  of  the  sale,  and  the  amount  of  the  tax  to 
be  paid, 

Tax  stamps  to  be  affixed. — To  which  bill,  memorandum, 
agreement,  or  other  evidence  of  sale  there  shall  be  affixed 
a  lawful  stamp  or  stamps  in  value  equal  to  the  amount 
of  tax  on  such  sale. 

One  stamped  memorandum  for  each  sale. — No  single 
sale  or  contract  of  sale  that  is  made  upon  an  exchange 
by  one  member  for  another  shall  require  to  be  evidenced 
by  more  than  one  such  stamped  memorandum. 

Memorandum  may  be  delivered  to  clearing  house. — If 
any  person  making  contracts  of  sale  for  future  delivery 
of  any  products  or  merchandise  at,  in,  or  on  any  ex- 
change shall  in  writing  appoint  the  clearing  house  for 
the  exchange  upon  which  such  sales  are  made  his  agent 
for  the  purposes  hereinafter  indicated,  such  clearing 
house  being  approved  by  the  Commissioner  of  Internal 
Eevenue,  and  shall  make  a  written  return  or  sheet  of 


550  INCOME   AND    FEDERAL    TAX    REPORTS 

each  such  sale  to  such  clearing  house  in  accordance  with 
these  regulations,  the  return  or  sheet  of  the  person  to 
the  clearing  house  shall  be  deemed  to  be  the  bill,  memo- 
randum, or  agreement  of  sale  required  to  be  delivered 
by  the  seller  to  the  buyer, 

Clearing  house  may  pay  tax. — And  the  clearing  house 
is  hereby  authorized  to  affix  to  such  return  or  sheet  the 
amount  of  stamps  required  for  each  contract  of  sale  in- 
dicated thereon,  and  to  cancel  the  stamps  so  affixed;  the 
affixing  and  cancellation  of  such  stamps  by  the  clearing 
house  to  be  held  to  be  that  of  the  person  making  such 
contracts  of  sale. 

Contents  of  return  to  clearing  house. — The  return  or 
sheet  of  sales  so  made  to  the  clearing  house  shall  in  re- 
spect of  each  sale  set  forth  the  date,  the  name  of  the 
seller,  the  name  of  the  purchaser,  the  amount  of  the  sale, 
and  the  matter  or  things  to  which  it  refers,  but  a  return 
for  more  than  one  sale  may  be  made  upon  the  same 
paper  or  sheet. 

Clearing  house  must  preserve  records  for  two  years. — 
The  clearing  house  shall  preserve  for  a  term  of  not  less 
than  two  years  each  return  or  sheet  made  to  it  by  any 
person  under  the  foregoing  regulations. 

Clearing  house  report  to  Commissioner. — Every  clear- 
ing house  so  acting  shall  include  in  the  monthly  return 
to  the  Commissioner  a  statement  of  the  amounts  of 
stamps  so  affixed  and  canceled  for  each  person. 
Monthly  returns  required  of  seller. — The  making  of  such 
return  by  the  clearing  house  shall  not  relieve  the  person 
making  such  sales  from  making  the  monthly  return  of 
his  transactions  required  by  these  regulations. 

Method  of  stamp  cancellation. — The  person  using  or 
affixing  stamps  shall  write  or  stamp  thereon  in  ink  his 
initials  and  the  day,  month,  and  year  on  which  the  same 
shall  be  used  or  affixed,  or  shall,  by  cutting  and  canceling 
the  stamp  with  a  machine  or  punch  affix  his  initials  and 
date  as  aforesaid,  so  deface  the  stamp  as  to  render  it 


WAR   STAMP   TAXES  551 

unfit  for  reuse.  In  addition  to  the  foregoing,  stamps  of 
the  value  of  10  cents  or  more  shall  have  three  parallel 
incisions  made  by  some  sharp  instrument  lengthwise 
through  the  stamp  after  the  same  has  been  attached  to 
the  document :  Provided,  This  will  not  be  required  where 
stamps  are  canceled  by  perforation.  The  cancellation 
by  either  method  should  not  so  deface -the  stamp  as  to 
prevent  its  denomination  and  genuineness  from  being 
readily  determined. 

Records  by  Sellers  and  Buyers 
Who  must  keep  records,  and  of  what. — Art.  6.  All  per- 
sons who  make  sales  or  contracts  of  sales,  including  so- 
called  "transferred  or  scratch  sales,"  "pass-outs,"  "pair- 
offs,"  or  "matched  trades,"  and  all  other  forms  of  sale 
of  any  product  or  merchandise  at,  on,  in,  or  under  the 
rules,  or  customs  of  any  exchange  for  future  delivery 
shall  keep  a  record  showing: 

(a)  Date  when  contract  was  made. 

(b)  Name  and  address  of  the  other  party  to  the  con- 

tract. 

(c)  Name  of  person  executing  the  contract. 

(d)  Whether  the  transaction  is  a  purchase  or  sale. 

(e)  Quantity  of  product,  merchandise,  or  commodity 

involved;  whether  in  tons,  pounds,  bales,  bush- 
els, bags,  mats,  barrels,  gallons,  or  other  unit 
of  measure  or  weight,  as  the  case  may  be. 

(f)  Name  of  product,  merchandise,  or  commodity,  in- 

cluding (if  not  a  basis  grade  contract)  grade, 
type,  sample,  or  description. 

(g)  Name  of  customer. 

(h)  Whether  the  contract  is  a  "basis  grade"  contract. 

(i)  Time  specified  in  contract  for  delivery. 

(j)  Specified  price  per  ton,  pound,  mat,  bale,  bag, 

bushel,  barrel,  gallon,  or  other  unit  of  measure 

or  weight,  as  the  case  may  be. 
(k)  Gross  amount  of  sale  or  purchase. 


552  INCOME   AND    FEDERAL    TAX    REPORTS 

(1)  Amount  of  tax  paid. 

(m)  Whether  the  order  for  sale  or  purchase  was  of 
domestic  (meaning  the  continental  United 
States)  or  foreign  origin  (meaning  from  coun- 
tries other  than  the  continental  United  States). 

(n)  Date  of  delivery  or  settlement. 

(o)  Method  of  fulfillment  or  settlement. 

Form  of  record. — Persons  who  use  such  forms  may  in- 
corporate additional  columns  which  would  be  of  use  to 
them,  such  columns  to  be  placed  in  such  positions  as  not 
to  interfere  with  the  columns  and  headings  prescribed. 
Such  record  forms  will  not  be  supplied  by  the  depart- 
ment. 

The  records  required  by  these  regulations  shall  be 
legibly  written  in  ink  and  kept  separate  in  books,  and 
contracts  of  sale  for  future  delivery  of  two  or  more  dis- 
tinct products  or  merchandise  shall  be  kept  separate. 
Records  preserved  by  seller. — Any  person  who  executes 
or  makes  such  contracts  of  sale  shall  preserve  the  trad- 
ing cards,  memoranda,  or  slips  of  each  transaction, 
Records  preserved  by  purchaser. — And  the  purchaser 
shall  preserve  the  bill,  memorandum,  or  evidence  of  sale 
to  which  the  stamps  are  affixed,  for  the  period  of  two 
years. 

Official  form  of  record. — The  form  of  the  record  re- 
quired by  these  regulations  shall  be  as  follows: 

Records  to  be  Kept  by  Clearing  Houses 

Clearing  house  records. — Art.  7.  All  persons  who  act 
in  the  capacity  of  a  clearing  house  or  clearing  associa- 
tion shall  keep  a  record  showing: 

(a)  Name    of    person    for   whom    each    contract    is 

cleared. 

(b)  Date  when  contract  was  made. 

(c)  Whether  the  transaction  is  a  purchase  or  sale. 

(d)  Quantity  of  product,  merchandise,  or  commodity 

involved,  whether  in  tons,  pounds,  bales,  bush- 


WAR    STAMP    TAXES  553 

els,  bags,  mats,  barrels,  gallons,  or  other  unit 
of  measure  or  weight,  as  the  case  may  be. 

(e)  Name  of  product,  merchandise,  or  commodity,  in- 

cluding (if  not  a  basis-grade  contract)  grade, 
type,  sample,  or  description. 

(f)  Whether  the  contract  is  a  basis-grade  contract. 

(g)  Time  specified  in  contract  for  delivery, 
(h)  Date  of  settlement. 

(i)  Method  of  settlement. 

Separate  records  for  each  product. — Records  of  sales 
for  future  delivery  of  two  or  more  distinct  products  or 
merchandise  must  be  kept  separate. 

Returns   by   Members   of  Exchanges 

Returns  required. — Art.  8.  All  persons  who  make  con- 
tracts of  sale  of  any  commodity,  product,  or  merchan- 
dise, at,  on,  or  in  any  exchange,  board  of  trade,  or  other 
similar  place  of  business,  for  future  delivery,  whether 
such  contracts  shall  be  cleared  and  adjusted  through  a 
clearing  house,  or  clearing  association,  or  directly  be- 
tween the  seller  and  buyer,  or  otherwise,  shall 
Time  of  return. — On  or  before  the  fifteenth  day  of  each 
month,  and  at  any  other  time  required  by  the  Commis- 
sioner of  Internal  Revenue,  make  return,  in  writing,  to 
the  Commissioner  of  Internal  Revenue,  or  some  officer 
designated  by  him,  for  the  preceding  month  or  any  other 
period,  verified  before  some  officer  authorized  to  admin- 
ister oaths,  showing: 

Contents  of  return. — (a)  The  number  of  contracts  of 
sale  and  purchase  of  each  product,  merchandise, 
or  commodity  brought  forward  from  the  preced- 
ing month. 

(b)  The  number  of  contracts  of  sale  and  purchase  of 

each  product,  merchandise,  or  commodity  dur- 
ing the  current  month. 

(c)  The  month  in  which  the  products,  merchandise,  or 

commodity  is  to  be  delivered. 


554  INCOME   AND    FEDERAL    TAX    REPORTS 

(d)  The  method  of  settlement  of  each  contract,  i.  e., 

whether  by  "actual  delivery,"  "notice,"  "ring," 
"direct,"  "transfer,"  or  "scratch  sale,"  "pair 
off,"  or  "matched,"  "pass  out,"  "set  off,"  "give 
up,"  through  a  clearing  house  or  clearing  asso- 
ciation, or  otherwise. 

(e)  The  gross  amount  of  the  contracts  of  sale. 

(f)  The  tax  paid  thereon. 

(g)  The  number  of  contracts  both  of  purchase  and 

sale  left  open  at  the  end  of  the  month, 
(h)  The  amount  of  stamps  on  hand  from  preceding 

month, 
(i)  The  amount  of  stamps  purchased  during  month, 
(j)  The  amount  of  stamps  used  during  month, 
(k)  Balance  of  stamps  on  hand  at  end  of  month. 
(1)  The  origin  of  the  order  of  the  contracts,  whether 

domestic  or  foreign. 
Form  of  return. — Such  returns  shall  be  made  upon 
forms  to  be  furnished,  upon  application,  by  the  collector 
of  internal  revenue,  or  other  designated  officer  of  the 
district  in  which  the  exchange,  board  of  trade,  or  other 
similar  place  is  located. 

Returns  by  Clearing  Houses 

Returns  required. — Art.  9.  Every  clearing  house,  or 
clearing  association,  shall, 

Time  of  return. — On  or  before  the  15th  day  of  each 
month,  and  at  any  other  time  required,  render  in  writ- 
ing, under  oath,  a  return,  for  the  preceding  month  or  for 
any  other  period  designated,  to  the  Commissioner  of 
Internal  Eevenue  of  all  facts  in  their  possession  show- 
ing: 

Contents  of  return. — (a)  The  number  of  contracts 
"long"  and  "short"  for  each  member  brought 
forward  from  the  preceding  month. 

(b)  The  number  of  contracts  bought  or  sold  by  each 
member  of  the  association. 


WAR   STAMP   TAXES  555 

(c)  The  number  of  tons,  pounds,  bales,  bushels,  bags, 

mats,  barrels,  or  gallons,  or  other  units  of 
weight  or  measure  involved  in  such  contracts, 
as  the  case  may  be. 

(d)  The  month  in  which  such  product,  merchandise, 

or  commodity  is  to  be  delivered. 

(e)  The  method  of  settlement  of  said  contracts — i.  e., 

whether  by  "set-off,"  "notice,"  or  "delivery,"  or 
by  any  other  method. 

(f )  The  number  of  open  contracts  "long"  and  "short" 

for    each    member    carried    to    the    following 

month. 
Form  of  return. — Such  returns  shall  be  made  upon 
forms  to  be  furnished,  upon  application,  by  the  collector 
of  internal  revenue  of  the  district,  or  other  designated 
officer,  in  which  the  clearing  house  or  clearing  associa- 
tion is  situated. 

Failure  to  Make   Returns — Agents 

In  default  of  return,  same  may  be  made  by  internal 
revenue  officer. — Art.  10.  If  any  person,  or  clearing 
house,  or  clearing  association,  required  to  make  returns 
by  this  act,  or  the  regulations  thereunder,  shall  fail, 
or  refuse  to  make  any  return  within  the  time  pre- 
scribed in  these  regulations,  or  designated  by  the  Com- 
missioner of  Internal  Revenue,  then  the  same  shall  be 
made  by  an  internal-revenue  officer,  upon  inspection 
of  the  books  and  papers  of  the  person,  or  clearing  house, 
or  clearing  association,  so  required; 
Penalty  attaches  to  such  default. — But  the  making  of 
said  return  by  an  internal-revenue  officer  shall  not  re- 
lieve the  person  in  default  from  any  penalty  incurred  by 
reason  of  his  failure  to  make  such  return. 

Authority  of  internal-revenue  officer. — Any  officer  des- 
ignated by  the  Commissioner  of  Internal  Revenue  shall 
have  authority  to  examine  the  books,  papers,  and  rec- 
ords kept  pursuant  to  these  regulations,  and  may  require 


556  INCOME   AND    FEDERAL    TAX    REPORTS 

the  production  of  any  other  books,  records,  papers,  or 
statements  of  account,  necessary  to  determine  any  lia- 
bility to  the  tax  imposed  by  this  act,  or  the  observance 
of  the  provisions  of  the  regulations  made  in  accordance 
therewith. 

Sale   of  Stamps 

Who  may  sell  stamps. — Art.  11.  No  persons  other  than 
a  collector  of  internal  revenue,  or  duly  authorized  deputy 
collector  of  internal  revenue,  assistant  treasurer,  or  des- 
ignated depositary  of  the  United  States,  in  the  district 
in  which  is  located  an  exchange,  shall  sell  or  expose  for 
sale,  traffic  in,  trade,  barter,  or  exchange  any  stamp  re- 
quired by  law  or  by  these  regulations  to  be  used  for  the 
payment  of  taxes  upon  sales  or  contracts  of  sale  of  any 
product  or  merchandise  for  future  delivery. 

Requisitions  for  stamps. — All  requisitions  for  such 
stamps  shall  be  made  in  writing  on  a  form  prescribed 
by  the  Commissioner  of  Internal  Eevenue  to  the  collector 
of  internal  revenue,  an  assistant  treasurer,  or  designated 
depositary  in  the  internal  revenue  district  in  which  the 
stamps  are  to  be  used,  giving  the  date  thereof,  the 
number  and  denomination  of  stamps  applied  for,  and 
the  name  and  address  of  the  purchaser,  and  shall  be 
signed  in  ink  by  the  person  receiving  the  stamps. 
Records  of  requisitions. — If  the  requisition  for  such 
stamps  shall  be  made  to  any  assistant  treasurer  or  des- 
ignated depositary  of  the  United  States,  such  assistant 
treasurer  or  designated  depositary  shall  keep  a  record 
thereof,  and  at  the  end  of  each  month  shall  file  such 
requisitions  with  his  monthly  report  with  the  collector 
of  internal  revenue  of  the  district  in  which  said  assistant 
treasurer  or  designated  depositary  is  located.  The  col- 
lector of  internal  revenue  shall  keep  the  requisitions  for 
such  stamps  made  to  him  and  those  filed  by  such  assist- 
ant treasurer  or  designated  depositary  separate  and 
apart  from  all  other  requisitions  for  stamps  and  pre- 
serve them  in  his  office  for  a  period  of  two  years. 


WAR    STAMP    TAXES  557 

Kind  of  stamps  authorized. — The  stamps  shall  be  of  a 
color  and  design  prescribed  by  the  Commissioner  of  In- 
ternal Revenue. 

Note 

Fines  and  penalties — enforcement. — For  the  provi- 
sions as  to  fines  and  penalties  applying  particularly  to 
violations  or  attempted  evasions  of  the  act  or  of  these 
regulations  reference  is  made  to  sections  802,  803,  807, 
subdivision  5,  and  1004  of  the  "Act  to  provide  revenue 
to  defray  war  expenses,  and  for  other  purposes,"  ap- 
proved October  3,  1917.  The  provisions  of  the  internal- 
revenue  laws  of  the  United  States,  so  far  as  applicable, 
including  sections  3173,  3174,  3175,  of  the  Revised  Stat- 
utes, as  amended,  apply  to  said  act. 

Time  drafts,  post-dated  checks  and  promissory  notes. — 
Drafts  or  checks  payable  otherwise  than  at  sight  or  on 
demand,  promissory  notes  (except  bank  notes  issued  for 
circulation),  and  each  renewal  of  the  same,  are  taxable 
as  follows:  for  a  sum  not  exceeding  $100  or  fractional 
part  thereof,  2  cents,  and  for  each  additional  $100  or 
fractional  part  thereof,  2  cents.  A  renewal,  for  the  pur- 
pose of  the  tax,  is  any  written  agreement  permitting  an 
extension  of  the  time  of  payment,  whether  a  new  note  is 
made  or  not. 

A  promissory  note  is  a  written  promise  to  pay  a  speci- 
fied sum  of  money  on  demand  or  at  a  specified  future 
time.  The  chief  distinction  between  promissory  notes 
and  bonds,  for  the  purpose  of  the  tax,  is  that  bonds  are 
issued  under  seal,  whereas  notes  are  not. 

Ordinary  checks  are  not  taxable.  Checks  dated  ahead, 
however,  are  payable  neither  at  sight  or  on  demand  and 
must  therefore  have  stamp  affixed. 

Drafts  drawn  in  foreign  countries  and  payable  in  the 
United  States  are  not  subject  to  the  tax. 

Drafts  drawn  in  the  United  States  and  payable  in  for- 


558  INCOME   AND    FEDERAL    TAX    REPORTS 

eign  countries  are  subject  to  the  tax,  if  payable  other- 
wise than  on  sight  or  on  demand. 

Drafts  payable  on  "arrival  of  goods"  and  "at  sight  or 
on  demand  after  arrival  of  goods,"  are  subject  to  the  tax. 

Policy  loan  and  premium  extension  agreements  are  not 
promissory  notes  within  the  meaning  of  the  law  and  are 
not  subject  to  the  stamp  tax. 

Conveyance  of  real  estate. — A  tax  of  50  cents  for  each 
$500  in  value  or  fraction  thereof  is  imposed  upon  all 
conveyances  of  lands,  tenements  or  other  realty,  when 
the  value,  exclusive  of  liens  thereon,  is  $100  or  more. 
No  tax  is  imposed  on  any  instrument  or  writing  given 
to  secure  a  debt.  Leases  of  real  estate  are  not  taxable ; 
neither  are  contracts  for  the  sale  of  real  estate,  making 
provision  for  future  delivery  by  deed. 

On  an  instrument  conveying  real  estate  there  should 
be  attached  a  tax  stamp  of  the  face  value  corresponding 
with  the  amount  representing  the  vendor's  equity  con- 
veyed. Where  an  exchange  of  equal  equities  in  real 
estate  is  made  between  two  persons  a  stamp  should  be 
attached  to  each  of  the  two  deeds,  corresponding  with 
the  amount  of  each  equity  exchanged.  In  determining 
the  amount  of  incumbrance  upon  real  estate  being  trans- 
ferred, no  consideration  is  to  be  given  to  new  incum- 
brances placed  upon  same  at  the  time  of,  or  after,  the 
sale.  Only  incumbrances  which  rest  o.n  the  property  be- 
fore the  sale  and  which  are  not  removed  by  the  sale  are 
to  be  taken  into  consideration. 

A  deed  issued  to  cover  a  gift  of  property  to  the  Gov- 
ernment, wherein  the  consideration  named  is  "desire  to 
promote  public  welfare  and  $1,"  or  "$1  and  other  valu- 
able considerations,"  is  not  taxable. 

Custom-house  entry. — Entry  of  any  goods,  wares  or 
merchandise  at  any  custom-house,  either  for  consump- 
tion or  warehousing,  is  taxable  as  follows :  not  exceeding 
$100  in  value,  25  cents;  exceeding  $100  and  not  exceed- 
ing $500  in  value,  50  cents ;  exceeding  $500  in  value,  $1. 


WAR    STAMP    TAXE8  559 

Entry  for  customs  withdrawal. — The  tax  on  an  entry  for 
the  withdrawal  of  any  goods  or  merchandise  from  cus- 
toms bonded  warehouse  is  50  cents. 

Passage  tickets. — Passage  tickets  one  way  or  round 
trip,  for  each  passenger,  sold  or  issued  in  the  United 
States  for  passage  by  any  vessel  to  a  port  or  place  not 
in  the  United  States,  Canada,  or  Mexico,  are  taxed  as 
follows:  if  costing  not  exceeding  $30,  $1;  costing  more  ^  > 
than  $30  and  not  exceeding  $60,  $3;  costing  more  than 
$60,  $5.  There  is  no  tax  on  such  tickets  costing  $10  or 
less.  It  will  be  noted  that  the  stamp  tax  covers  foreign 
passage  tickets  only.  Passage  tickets  beween  points  in 
the  United  States  are  taxed  under  the  Public  Utilities 
tax. 

Voting  proxies. — Proxies  for  voting  at  any  election  for 
officers,  or  meeting  for  the  transaction  of  business,  of 
any  incorporated  company  or  association,  except  reli- 
gious, educational,  charitable,  fraternal,  or  literary  soci- 
eties, or  public  cemeteries,  are  taxed  at  the  rate  of  10 
cents  for  each  proxy. 

Power  of  attorney. — Powers  of  attorney  granting  au- 
thority to  do  or  perform  some  act  for  or  in  behalf  of  the 
grantor,  which  authority  is  not  otherwise  vested  in  the 
grantee,  are  taxed  25  cents  each. 

There  is  no  tax  upon  the  power  of  attorney  contained 
in  a  transfer  by  assignment,  absolute  or  as  collateral  se- 
curity, of  an  interest  in  a  contract  of  insurance,  if  the 
power  of  attorney  grants  authority  to  do  or  perform 
only  such  acts  for  or  in  behalf  of  the  assignor  as  are 
otherwise  vested  in  the  assignee. 

But  no  stamps  are  required  on  any  papers  necessary 
to  be  used  for  the  collection  of  claims  from  the  United 
States  or  from  any  State  for  pensions,  back  pay,  bounty, 
or  for  property  lost  in  the  military  or  naval  service,  or 
upon  powers  of  attorney  required  in  bankruptcy  cases. 

Playing  cards. — A  tax  of  five  cents  per  pack  is  imposed, 
in  addition  to  the  tax  previously  imposed  and  which  still 


560  INCOME   AND    FEDERAL    TAX    REPORTS 

remains  in  effect,  on  playing  cards  manufactured  or  im- 
ported, and  sold,  or  removed  for  sale  after  the  passage 
of  the  Act.  This  additional  stamp  tax  on  playing  cards 
became  effective  October  4,  1917,  making  the  total  tax 
7  cents  per  pack. 

This  tax  does  not  apply  to  such  cards  tax-paid  prior 
to  October  4  at  the  two-cent  rate  under  the  Act  of  Aug. 
28,  1894,  in  the  hands  of  jobbers  and  retail  dealers,  un- 
less the  packs  have  been  broken  and  cards  repacked,  in 
which  event  the  dealer  would  be  subject  to  the  manufac- 
turer's tax. 

Under  authority  of  sections  1001  and  1006,  providing 
for  the  collection  of  taxes  of  this  class  under  regula- 
tions prescribed  by  the  Commissioner  of  Internal  Keve- 
nue  and  for  the  use  of  stamps  on  hand  at  the  passage 
of  the  Act,  the  following  regulations  are  promulgated 
by  the  Treasury  Department: 

"Every  manufacturer  and  importer  of  playing  cards 
will  render  to  the  collector  of  the  district  wherein  the 
factory  is  located,  a  sworn  inventory  in  duplicate  on 
or  before  October  31,  1917,  showing  separately  the  num- 
ber of  stamped  and  unstamped  packs  on  hand  at  the 
beginning  of  business  October  4th,  and  likewise  the 
number  of  attached  and  unattached  stamps  at  the  rate 
of  two  cents.  These  inventories  may  be  rendered  on 
Form  215,  modified  to  suit  the  nature  of  the  article,  or 
in  typewritten  form. 

"On  October  31,  or  within  ten  days  thereafter,  a  re- 
turn under  oath  in  duplicate  must  be  rendered,  covering 
the  period  October  4  to  31  inclusive,  showing  the  num- 
ber of  packs  of  cards  manufactured  or  imported,  the 
number  withdrawn  tax-paid,  the  name  and  address  of 
each  person,  firm  or  corporation  to  whom  such  cards 
may  be  consigned  or  sold,  the  number  and  total  value 
at  the  rate  of  two  cents  of  stamps  affixed,  and  the  addi- 
tional tax  of  five  cents  per  pack  due  thereon. 

"This  return  will  be   rendered  for  each  subsequent 


WAR    STAMP   TAXES  561 

month  on  the  last  day  thereof,  or  on  or  before  the  tenth 
day  of  the  succeeding  month,  until  the  supply  of  stamps 
at  the  old  rate  on  hand  is  exhausted. 

"Forms  for  rendering  these  returns  may  be  obtained 
upon  application  to  the  collector  of  the  district ;  or  manu- 
facturers or  importers,  if  they  so  desire,  may  make  up 
such  monthly  return  upon  the  typewriter,  provided,  it 
conforms  in  detail  with  that  prescribed. 

"Collectors  will  carefully  verify  these  inventories  and 
returns  and  enter  for  assessment  the  additional  tax  at 
5  cents  shown  due  from  manufacturers  or  importers 
until  the  stock  of  stamps,  at  the  rate  of  two  cents,  held 
by  the  tax  payer  is  exhausted.  Thereafter  every  manu- 
facturer and  importer  will  be  required  to  render  such 
return  for  each  month  during  continuance  in  business, 
but  the  additional  tax  will  not  be  noted  thereon,  as  all 
stamps  purchased  from  the  collector  on  and  after  Octo- 
ber 4  will  be  sold  and  accounted  for  at  the  new  rate. 

"On  and  after  October  4  the  collectors  selling  stamps 
on  hand  of  the  rate  of  two  cents  will  overprint  same, 
require  payment  and  account  therefor  at  the  rate  of 
seven  cents  per  pack." 

Parcel  post  packages. — Parcel  post  packages  on  which 
the  postage  amounts  to  25  cents  or  more  are  taxed  at 
the  rate  of  1  cent  for  each  25  cents  or  fractional  part 
thereof  charged  for  transportation.  The  tax  is  based 
on  transportation  charges  alone,  so  that  C.  0.  D.  or  in- 
surance charges  are  not  to  be  reckoned  in  computing  the 
tax.  The  stamp  must  be  affixed  by  the  sender  and  can- 
celed by  him  before  the  package  is  mailed,  care  being 
taken  not  to  cancel  the  postage  stamps.  The  stamps 
for  tax  payment  must  be  revenue  stamps  and  not  extra 
postage  stamps.  Packages  upon  which  the  tax  has  not 
been  so  paid  will  not  be  transported. 

The  tax  must  be  paid  on  parcel  post  packages  mailed 
from  one  point  in  the  United  States  to  another,  but  pack- 


562  IX COME   AND    FEDERAL    TAX    REPORTS 

ages  sent  to  foreign  countries,  including  Porto  Rico,  are 
not  taxable. 
For  tax  on  express  packages,  see  page  581. 

Redemption  of  unused  stamps. — Claim  for  allowance  for 
or  redemption  of  unused  stamps  may  be  made  by  the 
bona  fide  owner  thereof  or  by  his  agent,  who  must  set 
forth  under  oath,  on  Form  46,  the  facts  relied  on  in  sup- 
port of  his  claim.  The  claim  should  be  supported  by  the 
certificate  of  the  deputy  collector  who  personally  has  in- 
vestigated the  statements  made  by  the  claimant,  and  by 
the  certificate  of  the  collector  for  whom  the  stamps  were 
purchased,  giving  such  information  as  the  Commissioner 
of  Internal  Revenue  may  desire.  Upon  allowance  of  the 
claim  by  the  Commissioner  the  claim  will  be  certified  by 
him  to  the  Auditor  for  the  Treasury  Department,  who, 
in  the  absence  of  fraud  or  miscalculation,  will  certify  the 
amount  allowed  to  the  Division  of  Bookkeeping  and 
Warrants. 

Redemption  of  stamps  affixed  to  documents  or  articles. — 
In  cases  where  stamps  have  been  affixed  to  documents 
or  articles  not  requiring  them  and  canceled,  or  where, 
by  error,  stamps  of  greater  value  than  necessary  have 
been  used,  the  procedure  is  substantially  the  same  as  in 
the  case  above.  The  stamps  should  be  returned  with 
the  claim  and  where  practicable,  accompanied  by  the  in- 
struments to  which  the  stamps  have  been  attached,  or 
certified  copies  thereof.  If  the  instrument  cannot  be 
sent  the  collector  may  instruct  his  deputy  to  visit  claim- 
ant's place  of  business,  examine  the  instrument  and  can- 
cel the  stamps  by  writing  across  them  the  words  "claim 
for  refund  filed." 

Method  of  payment. — Adhesive  stamps  for  the  payment 
of  these  taxes  may  be  purchased  from  collectors  of  the 
various  districts  and  at  post  offices  and  banks  designated 
as  United  States  depositaries.  Stamps  have  so  far  been 
issued  in  various  denominations  up  to  $2,  but  it  is  in- 


WAR    STAMP    TAXES  563 

tended  later  to  issue  denominations  as  high  as  $1,000, 
for  Stock  Exchange  transactions. 

Stamps  denoting  the  amount  of  the  tax  must  be 
affixed  and  canceled  by  writing  or  stamping  upon  them 
the  initials  of  the  person  or  concern  using  or  affixing 
them,  together  with  the  date  when  so  affixed.  Stamps 
of  the  value  of  10  cents  or  more  should  also  be  mutilated 
by  making  three  parallel  incisions  lengthwise  with  a 
sharp  instrument;  proper  perforations  are  permissible 
in  lieu  of  the  incisions. 

Original  documents  only  need  to  be  stamped;  copies 
should  merely  bear  a  statement  to  the  effect  that  stamps 
are  attached  to  the  original. 

Penalties. — The  penalties  provided  for  not  complying 
with  the  stamp  provisions  are  as  follows: 

"That  whoever  makes,  signs,  issues,  or  accepts,  or 
causes  to  be  made,  signed,  issued,  or  accepted,  any  in- 
strument, document,  or  paper  of  any  kind  or  description 
whatever,  without  the  full  amount  of  tax  thereon  being 
duly  paid;  consigns  or  ships,  or  causes  to  be  consigned 
or  shipped,  by  parcel  post,  any  parcel,  package,  or  ar- 
ticle without  the  full  amount  of  tax  being  duly  paid; 
makes  use  of  any  adhesive  stamp  to  denote  any  tax  im- 
posed by  law  without  canceling  or  obliterating  such 
stamp  as  prescribed,  is  guilty  of  a  misdemeanor,  and 
upon  conviction  thereof  shall  pay  a  fine  of  not  less  than 
$100  for  each  offence." 

It  will  be  noted  that  the  foregoing  penalties  apply 
equally  to  the  maker  and  to  the  acceptor  of  any  docu- 
ment upon  which  the  tax  has  not  been  paid. 

The  penalty  for  fraudulent  use  of  stamps,  which  in- 
cludes the  fraudulent  removal  of  stamps  from  documents, 
etc.,  the  use  of  previously  canceled  stamps  or  having 
in  possession  renovated  stamps  previously  used,  is  a 
fine  of  not  over  $1,000  or  imprisonment  for  not  more 
than  five  years,  together  with  forfeiture  to  the  United 
States  of  the  article  upon  which  the  stamp  was  used. 


CHAPTER  XXVI 

WAR  STAMP  TAXES  LAW 

BEING  TITLE  VIII  OF  "AN  ACT  TO  PROVIDE  REVENUE 
TO  DEFRAY  WAR  EXPENSES,  AND  FOR  OTHER 
PURPOSES,"   APPROVED   OCTOBER   3,    1917. 
(PUBLIC— No.  50— 65th  CONGRESS.)  IN  EF- 
FECT OCTOBER  4,   1917,   UNLESS 
OTHERWISE  SPECIALLY 
PROVIDED 


TITLE   VIII.— WAR   STAMP    TAXES 
Effective  Dec.  1,  1917 

Stamp  taxes  on  bonds,  certificates  of  stock,  and  other 
documents. — Sec.  800  [of  the  general  revenue  Act  of 
which  this  Title  is  a  part].  That  on  and  after  the  first 
day  of  December,  nineteen  hundred  and  seventeen,  there 
shall  be  levied,  collected,  and  paid,  for  and  in  respect  of 
the  several  bonds,  debentures,  or  certificates  of  stock 
and  of  indebtedness,  and  other  documents,  instruments, 
matters,  and  things  mentioned  and  described  in  Schedule 
A  of  this  title,  or  for  or  in  respect  of  the  vellum,  parch- 
ment, or  paper  upon  which  such  instruments,  matters, 
or  things,  or  any  of  them,  are  written  or  printed,  by  any 
person,  corporation,  partnership,  or  association  who 
makes,  signs,  issues,  sells,  removes,  consigns,  or  ships 
the  same,  or  for  whose  use  or  benefit  the  same  are  made, 
signed,  issued,  sold,  removed,  consigned,  or  shipped,  the 
several  taxes  specified  in  such  schedule. 

No  tax  on  bonds  or  other  instruments  of  U.  S.,  State, 
Municipal,  or  Foreign  Governments. — Sec.  801.    That  there 

564 


WAR    STAMP    TAXES    LAW  565 

shall  not  be  taxed  under  this  title  any  bond,  note,  or 
other  instrument,  issued  by  the  United  States,  or  by  any 
foreign  Government,  or  by  any  State,  Territory,  or  the 
District  of  Columbia,  or  local  subdivision  thereof,  or 
municipal  or  other  corporation  exercising  the  taxing 
power,  when  issued  in  the  exercise  of  a  strictly  govern- 
mental, taxing,  or  municipal  function;  or  stocks  and 
bonds  issued  by  co-operative  building  and  loan  associa- 
tions which  are  organized  and  operated  exclusively  for 
the  benefit  of  their  members  and  make  loans  only  to 
their  shareholders,  or  by  mutual  ditch  or  irrigating  com- 
panies. 

Penalty  for  failure  to  pay  tax,  affix  or  cancel  stamps. — 
Sec.  802.    That  whoever— 

(a)  Makes,  signs,  issues,  or  accepts,  or  causes  to  be 
made,  signed,  issued,  or  accepted,  any  instrument,  docu- 
ment or  paper  of  any  kind  or  description  whatsoever 
without  the  full  amount  of  tax  thereon  being  duly  paid. 

(b)  Consigns  or  ships,  or  causes  to  be  consigned  or 
shipped,  by  parcel  post  any  parcel,  package,  or  article 
without  the  full  amount  of  tax  being  duly  paid: 

(c)  Manufactures  or  imports  and  sells,  or  offers  for 
sale,  or  causes  to  be  manufactured  or  imported  and  sold, 
or  offered  for  sale,  any  playing  cards,  package,  or  other 
article  without  the  full  amount  of  tax  being  duly  paid; 

(d)  Makes  use  of  an  adhesive  stamp  to  denote  any 
tax  imposed  by  this  title  without  cancelling  or  obliterat- 
ing such  stamp  as  prescribed  in  section  eight  hundred 
and  four; 

Is  guilty  of  a  misdemeanor  and  upon  conviction  there- 
of shall  pay  a  fine  of  not  more  than  $100  for  each  of- 
fense. 

Penalty  for  fraudulently  using  stamps. — Sec.  803.  That 
whoever — 

(a)  Fraudulently  cuts,  tears,  or  removes  from  any 
vellum,  parchment,  paper,  instrument,  writing,  package, 
or  article,  upon  which  any  tax  is  imposed  by  this  title, 


566  INCOME    AND    FEDERAL    TAX    REPORTS 

any  adhesive  stamp  or  the  impression  of  any  stamp,  die, 
plate,  or  other  article  provided,  made,  or  used  in  pursu- 
ance of  this  title; 

(b)  Fraudulently  uses,  joins,  fixes,  or  places  to,  with, 
or  upon  any  vellum,  parchment,  paper,  instrument,  writ- 
ing, package,  or  article,  upon  which  any  tax  is  imposed 
by  this  title,  (1)  any  adhesive  stamp,  or  the  impression 
of  any  stamp,  die,  plate,  or  other  article,  which  has  been 
cut,  torn,  or  removed  from  any  other  vellum,  parchment, 
paper,  instrument  writing,  package,  or  article,  upon 
which  any  tax  is  imposed  by  this  title;  or  (2)  any  ad- 
hesive stamp  or  the  impression  of  any  stamp,  die,  plate, 
or  other  article  of  insufficient  value;  or  (3)  any  forged 
or  counterfeit  stamp,  or  the  impression  of  any  forged 
or  counterfeited  stamp,  die,  plate,  or  other  article; 

(c)  Willfully  removes,  or  alters  the  cancellation,  or 
defacing  marks  of,  or  otherwise  prepares,  any  adhesive 
stamp,  with  intent  to  use,  or  cause  the  same  to  be  used, 
after  it  has  been  already  used,  or  knowingly  or  willfully 
buys,  sells,  offers  for  sale  or  gives  away,  any  such 
washed  or  restored  stamp  to  any  person  for  use,  or 
knowingly  uses  the  same; 

(d)  Knowingly  and  without  lawful  excuse  (the  burden 
of  proof  of  such  excuse  being  on  the  accused)  has  in 
possession  any  washed,  restored,  or  altered  stamp,  which 
has  been  removed  from  any  vellum,  parchment,  paper, 
instrument,  writing,  package,  or  article,  is  guilty  of  a 
misdemeanor,  and  upon  conviction  shall  be  punished  by 
a  fine  of  not  more  than  $1,000,  or  by  imprisonment  for 
not  more  than  five  years,  or  both,  in  the  discretion  of 
the  court,  and  any  such  reused,  canceled,  or  counterfeit 
stamp  and  the  vellum,  parchment,  document,  paper, 
package,  or  article  upon  which  it  is  placed  or  impressed 
shall  be  forfeited  to  the  United  States. 

Method  of  cancelling  stamps. — Sec.  804.  That  whenever 
an  adhesive  stamp  is  used  for  denoting  any  tax  imposed 
by  this  title,  except  as  hereinafter  provided,  the  person 


WAR    STAMP    TAXES    LAW  567 

corporation,  partnership,  or  association,  using  or  affix- 
ing the  same  shall  write  or  stamp  or  cause  to  be  written 
or  stamped  thereupon  the  initials  of  his  or  its  name  and 
the  date  upon  which  the  same  is  attached  or  used,  so 
that  the  same  may  not  again  be  used:  Provided,  That 
the  Commissioner  of  Internal  Revenue  may  prescribe 
such  other  method  for  the  cancellation  of  such  stamps 
as  he  may  deem  expedient. 

Methods  of  preparing,  distributing  and  affixing  stamps. — 
Sec.  805.  (a)  That  the  Commissioner  of  Internal  Rev- 
enue shall  cause  to  be  prepared  and  distributed  for  the 
payment  of  the  taxes  prescribed  in  this  title  suitable 
stamps  denoting  the  tax  on  the  document,  articles,  or 
thing  to  which  the  same  may  be  affixed,  and  shall  pre- 
scribe such  method  for  the  affixing  of  said  stamps  in 
substitution  for  or  in  addition  to  the  method  provided 
in  this  title,  as  he  may  deem  expedient. 

(b)  The  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  is  authorized 
to  procure  any  of  the  stamps  provided  for  in  this  title 
by  contract  whenever  such  stamps  can  not  be  speedily 
prepared  by  the  Bureau  of  Engraving  and  Printing ;  but 
this  authority  shall  expire  on  the  first  day  of  January, 
nineteen  hundred  and  eighteen,  except  as  to  imprinted 
stamps  furnished  under  contract,  authorized  by  the  Com- 
missioner of  Internal  Revenue. 

(c)  All  internal-revenue  laws  relating  to  the  assess- 
ment and  collection  of  taxes  are  hereby  extended  to  and 
made  a  part  of  this  title,  so  far  as  applicable,  for  the 
purpose  of  collecting  stamp  taxes  omitted  through  mis- 
take or  fraud  from  any  instrument,  document,  paper, 
writing,  parcel,  package,  or  article  named  herein. 

Sale  of  stamps  by  Post-offices. — Sec.  806.  That  the  Com- 
missioner of  Internal  Revenue  shall  furnish  to  the  Post- 
master General  without  prepayment  a  suitable  quantity 
of  adhesive  stamps  to  be  distributed  to  and  kept  on  sale 
by  the  various  postmasters  in  the  United  States.     The 


568  INCOME    AND    FEDERAL    TAX    REPORTS 

Postmaster  General  may  require  each  such  postmaster 
to  give  additional  or  increased  bond  as  postmaster  for 
the  value  of  the  stamps  so  furnished,  and  each  such 
postmaster  shall  deposit  the  receipts  from  the  sale  of 
such  stamps  to  the  credit  of  and  render  accounts  to  the 
Postmaster  General  at  such  times  and  in  such  form  as 
he  may  by  regulations  prescribe.  The  Postmaster  Gen- 
eral shall  at  least  once  monthly  transfer  all  collections 
from  this  source  to  the  Treasury  as  internal-revenue 
collections. 

Sale  of  stamps  by  United  States  depositaries. — Sec.  807. 
That  the  collectors  of  the  several  districts  shall  furnish 
without  prepayment  to  any  assistant  treasurer  or  desig- 
nated depositary  of  the  United  States  located  in  their 
respective  collection  districts  a  suitable  quantity  of  ad- 
hesive stamps  for  sale.  In  such  cases  the  collector  may 
require  a  bond,  with  sufficient  sureties,  to  an  amount 
equal  to  the  value  of  the  adhesive  stamps  so  furnished, 
conditioned  for  the  faithful  return,  whenever  so  required 
of  all  quantities  or  amounts  undisposed  of,  and  for  the 
payment  monthly  of  all  quantities  or  amounts  sold  or 
not  remaining  on  hand.  The  Secretary  of  the  Treasury 
may  from  time  to  time  make  such  regulations  as  he  may 
find  necessary  to  insure  the  safe-keeping  or  prevent  the 
illegal  use  of  all  such  adhesive  stamps. 

SCHEDULE    A.— STAMP    TAXES. 

Tax  on  bonds,  debentures  and  certificates  of  indebtedness. 
— 1.  Bonds  of  indebtedness:  Bonds,  debentures,  or 
certificates  of  indebtedness  issued  on  and  after  the  first 
day  of  December,  nineteen  hundred  and  seventeen,  by 
any  person,  corporation,  partnership,  or  association,  on 
each  $100  of  face  value  or  fraction  thereof,  5  cents: 
Provided,  That  every  renewal  of  the  foregoing  shall  be 
taxed  as  a  new  issue;  Provided  further,  That  when  a 
bond    conditioned    for   the    repayment   or    payment   of 


WAR    8TAMP    TAXES    LAW  569 

money  is  given  in  a  penal  sum  greater  than  the  debt 
secured,  the  tax  shall  be  based  upon  the  amount  secured. 

Tax  on  surety  bonds. — 2.  Bonds,  indemnity  and  surety : 
Bonds  for  indemnifying  any  person,  corporation,  part- 
nership, or  corporation  who  shall  have  become  bound  or 
engaged  as  surety,  and  all  bonds  for  the  due  execution 
or  performance  of  any  contract,  obligation,  or  require- 
ment, or  the  duties  of  any  office  or  position,  and  to  ac- 
count for  money  received  by  virtue  thereof,  and  all 
other  bonds  of  any  description,  except  such  as  may  be 
required  in  legal  proceedings,  not  otherwise  provided 
for  in  this  schedule,  50  cents:  Provided,  That  where  a 
premium  is  charged  for  the  execution  of  such  bonds  the 
tax  shall  be  paid  at  the  rate  of  one  per  centum  on  each 
dollar  or  fractional  part  thereof  of  the  premium  charged : 
Provided  further,  That  policies  of  reinsurance  shall  be 
exempt  from  the  tax  imposed  by  this  subdivision. 

Tax  on  original  issues  of  capital  stock — 3.  Capital  stock, 
issue:  On  each  original  issue,  whether  on  organization 
or  reorganization,  of  certificates  of  stock  by  any  associa- 
tion, company,  or  corporation,  on  each  $100  of  face 
value  or  fraction  thereof,  5  cents :  Provided,  That  where 
capital  stock  is  issued  without  face  value,  the  tax  shall 
be  5  cents  per  share,  unless  the  actual  value  is  in  excess 
of  $100  per  share,  in  which  case  the  tax  shall  be  5  cents 
on  each  $100  of  actual  value  or  fraction  thereof. 

The  stamps  representing  the  tax  imposed  by  this  sub- 
division shall  be  attached  to  the  stock  books  and  not  to 
the  certificates  issued. 

Tax  on  sales  or  transfers  of  stock. — 4.  Capital  stock, 
sales  or  transfers :  On  all  sales,  or  agreements  to  sell, 
or  memoranda  of  sales  or  deliveries  of,  or  transfers  of 
legal  title  to  shares  or  certificates  of  stock  in  any  asso- 
ciation, company,  or  corporation,  whether  made  upon  or 
shown  by  the  books  of  the  association,  company,  or 
corporation,  or  by  any  assignment  in  blank,  or  by  any 
delivery,  or  by  any  paper  or  agreement  or  memorandum 


570  INCOME   AND    FEDERAL    TAX   REPORTS 

or  other  evidence  of  transfer  or  sale,  whether  entitling 
the  holder  in  any  manner  to  the  benefit  of  such  stock  or 
not,  on  each  $100  of  face  value  or  fraction  thereof,  2 
cents,  and  where  such  shares  of  stock  are  without  par 
value,  the  tax  shall  be  2  cents  on  the  transfer  or  sale  or 
agreement  to  sell  on  each  share,  unless  the  actual  value 
thereof  is  in  excess  of  $100  per  share,  in  which  case  the 
tax  shall  be  2  cents  on  each  $100  of  actual  value  or  frac- 
tion thereof:  Provided,  That  it  is  not  intended  by  this 
title  to  impose  a  tax  upon  an  agreement  evidencing  a 
deposit  of  stock  certificates  as  collateral  security  for 
money  loaned  thereon,  which  stock  certificates  are  not 
actually  sold,  nor  upon  such  stock  certificates  so  de- 
posited: Provided  further,  That  the  tax  shall  not  be 
imposed  upon  deliveries  or  transfers  to  a  broker  for 
sale,  nor  upon  deliveries  or  transfers  by  a  broker  to  a 
customer  for  whom  and  upon  whose  order  he  has  pur- 
chased same,  but  such  deliveries  or  transfers  shall  be 
accompanied  by  a  certificate  setting  forth  the  facts: 
Provided  further,  That  in  case  of  sale  where  the  evi- 
dence of  transfer  is  shown  only  by  the  books  of  the  com- 
pany the  stamp  shall  be  placed  upon  such  books;  and 
where  the  change  of  ownership  is  by  transfer  of  the 
certificate  the  stamp  shall  be  placed  upon  the  certificate ; 
and  in  cases  of  an  agreement  to  sell  or  where  the  trans- 
fer is  by  delivery  of  the  certificate  assigned  in  blank 
there  shall  be  made  and  delivered  by  the  seller  to  the 
buyer  a  bill  or  memorandum  of  such  sale,  to  which  the 
stamp  shall  be  aifixed ;  and  every  bill  or  memorandum  of 
sale  or  agreement  to  sell  before  mentioned  shall  show 
the  date  thereof,  the  name  of  the  seller,  the  amount  of 
the  sale,  and  the  matter  or  thing  to  which  it  refers. 
Any  person  or  persons  liable  to  pay  the  tax  as  herein 
provided,  or  anyone  who  acts  in  the  matter  as  agent  or 
broker  for  such  person  or  persons  who  shall  make  any 
such  sale,  or  who  shall  in  pursuance  of  any  such  sale 
deliver  any  stock  or  evidence  of  the  sale  of  any  stock 


WAR    STAMP    TAXES    LAW  571 

or  bill  or  memorandum  thereof,  as  herein  required, 
without  having  the  proper  stamps  affixed  thereto  with 
intent  to  evade  the  foregoing  provisions  shall  be  deemed 
guilty  of  a  misdemeanor,  and  upon  conviction  thereof 
shall  pay  a  fine  of  not  exceeding  $1,000,  or  be  im- 
prisoned not  more  than  six  months,  or  both,  at  the  dis- 
cretion of  the  court. 

Tax  on  sales  of  produce  on  exchanges. — 5.  Produce,  sales 
of,  on  exchange:  Upon  each  sale,  agreement  of  sale,  or 
agreement  to  sell,  including  so-called  transferred  or 
scratch  sales,  any  products  or  merchandise  at  any  ex- 
change, or  board  of  trade,  or  other  similar  place,  for 
future  delivery,  for  each  $100  in  value  of  the  merchan- 
dise covered  by  said  sale  or  agreement  of  sale  or  agree- 
ment to  sell,  2  cents,  and  for  each  additional  $100  or 
fractional  part  thereof  in  excess  of  $100,  2  cents:  Pro- 
vided, That  on  eveiy  sale  or  agreement  of  sale  or  agree- 
ment to  sell  as  aforesaid  there  shall  be  made  and  deliv- 
ered by  the  seller  to  the  buyer  a  bill,  memorandum, 
agreement,  or  other  evidence  of  such  sale,  agreement  of 
sale,  or  agreement  to  sell,  to  which  there  shall  be  affixed 
a  lawful  stamp  or  stamps  in  value  equal  to  the  amount 
of  the  tax  on  such  sale :  Provided  further,  That  sellers 
of  commodities  described  herein,  having  paid  the  tax 
provided  by  this  subdivision,  may  transfer  such  con- 
tracts to  a  clearing  house  corporation  or  association, 
and  such  transfer  shall  not  be  deemed  to  be  a  sale,  or 
agreement  of  sale,  or  an  agreement  to  sell  within  the 
provisions  of  this  Act,  provided  that  such  transfer  shall 
not  vest  any  beneficial  interest  in  such  clearing  house 
association  but  shall  be  made  for  the  sole  purpose  of 
enabling  such  clearing  house  association  to  adjust  and 
balance  the  accounts  of  the  members  of  said  clearing 
house  association  on  their  several  contracts.  And  every 
such  bill,  memorandum,  or  other  evidence  of  sale  or 
agreement  to  sell  shall  show  the  date  thereof,  the  name 
of  the  seller,  the  amount  of  the  sale,  and  the  matter  or 


572  INCOME   AND    FEDERAL    TAX   REPORTS 

thing  to  which  it  refers;  and  any  person  or  persons 
liable  to  pay  the  tax  as  herein  provided,  or  anyone  who 
acts  in  the  matter  as  agent  or  broker  for  such  person  or 
persons,  who  shall  make  any  such  sale  or  agreement  of 
sale,  or  agreement  to  sell,  or  who  shall,  in  pursuance  of 
any  such  sale,  agreement  of  sale,  or  agreement  to  sell, 
deliver  any  such  products  or  merchandise  without  a 
bill,  memorandum,  or  other  evidence  thereof  as  herein 
required,  or  who  shall  deliver  such  bill,  memorandum, 
or  other  evidence  of  sale,  or  agreement  to  sell,  without 
having  the  proper  stamps  affixed  thereto,  with  intent  to 
evade  the  foregoing  provisions,  shall  be  deemed  guilty 
of  a  misdemeanor,  and  upon  conviction  thereof  shall  pay 
a  fine  of  not  exceeding  $1,000,  or  be  imprisoned  not  more 
than  six  months,  or  both,  at  the  discretion  of  the  court. 

That  no  bill,  memorandum,  agreement,  or  other  evi- 
dence of  such  sale,  or  agreement  of  sale,  or  agreement 
to  sell,  in  case  of  cash  sales  of  products  or  merchandise 
for  immediate  or  prompt  delivery  which  in  good  faith 
are  actually  intended  to  be  delivered  shall  be  subject  to 
this  tax. 

Tax  on  drafts,  promissory  notes  and  post-dated  checks. — 

6.  Drafts  or  checks  payable  otherwise  than  at  sight 
or  on  demand,  promissory  notes,  except  bank  notes 
issued  for  circulation,  and  for  each  renewal  of  the  same, 
for  a  sum  not  exceeding  $100,  2  cents ;  and  for  each  ad- 
ditional $100  or  fractional  part  thereof,  2  cents. 

Tax  on  deeds  and  other  instruments  of  conveyance. — 7. 
Conveyance:  Deed,  instrument,  or  writing,  whereby  any 
lands,  tenements,  or  other  realty  sold  shall  be  granted, 
assigned,  transferred,  or  otherwise  conveyed  to,  or 
vested  in,  the  purchaser  or  purchasers,  or  any  other 
person  or  persons,  by  his,  her,  or  their  direction,  when 
the  consideration  or  value  of  the  interest  or  property 
conveyed,  exclusive  of  the  value  of  any  lien  or  encum- 
brance remaining  thereon  at  the  time  of  sale,  exceeds 
$100  and  does  not  exceed  $500,  50  cents;  and  for  each 


WAR    STAMP    TAXES    LAW  573 

additional  $500  or  fractional  part  thereof  50  cents: 
Provided,  That  nothing  contained  in  this  paragraph 
shall  be  so  construed  as  to  impose  a  tax  npon  any  in- 
strument or  writing  given  to  secure  a  debt. 

Tax  on  custom-house  entries. — 8.  Entry  of  any  goods, 
wares,  or  merchandise  at  any  custom-house,  either  for 
consumption  or  warehousing,  not  exceeding  $100  in 
value,  25  cents ;  exceeding  $100  and  not  exceeding  $500 
in  value,  50  cents;  exceeding  $500  in  value,  $1. 

Tax  on  withdrawals  from  bonded  warehouse. — 9.  Entry 
for  the  withdrawal  of  any  goods  or  merchandise  from 
customs  bonded  warehouse,  50  cents. 

Tax  on  passage  tickets. — 10.  Passage  ticket,  one  way  or 
round  trip,  for  each  passenger,  sold  or  issued  in  the 
United  States  for  passage  by  any  vessel  to  a  port  or 
place  not  in  the  United  States,  Canada,  or  Mexico,  if 
costing  not  exceeding  $30,  $1 ;  costing  more  than  $30  and 
not  exceeding  $60,  $3;  costing  more  than  $60,  $5: 

Provided,  That  such  passage  tickets,  costing  $10  or 
less,  shall  be  exempt  from  taxation. 

Tax  on  proxies. — 11.  Proxy  for  voting  at  any  election 
for  officers,  or  meeting  for  the  transaction  of  business, 
of  any  incorporated  company  or  association,  except  re- 
ligious, educational,  charitable,  fraternal,  or  literary  so- 
cieties, or  public  cemeteries,  10  cents. 

Tax  on  powers  of  attorney. — Power  of  attorney  grant- 
ing authority  to  do  or  perform  some  act  for  or  in  behalf 
of  the  grantor,  which  authority  is  not  otherwise  vested 
in  the  grantee,  25  cents:  Provided,  That  no  stamps 
shall  be  required  upon  any  papers  necessary  to  be  used 
for  the  collection  of  claims  from  the  United  States  or 
from  any  State  for  pensions,  back  pay,  bounty,  or  for 
property  lost  in  the  military  or  naval  service  or  upon 
powers  of  attorney  required  in  bankruptcy  cases. 

Tax  on  playing  cards. — 13.  Playing  cards :  Upon  every 
pack  of  playing  cards  containing  not  more  than  fifty- 
four  cards,  manufactured  or  imported,  and  sold,  or  re- 


574  INCOME    AND    FEDERAL    TAX    REPORTS 

moved  for  consumption,  or  sale,  after  the  passage  of 
this  Act,  a  tax  of  5  cents  per  pack  in  addition  to  the  tax 
imposed  under  existing  law.1 

Tax  upon  parcel-post  packages. — 14.  Parcel-post  pack- 
ages: Upon  every  parcel  or  package  transported  from 
one  point  in  the  United  States  to  another  by  parcel- 
post  on  which  the  postage  amounts  to  25  cents  or  more, 
a  tax  of  1  cent  for  each  25  cents  or  fractional  part  there- 
of charged  for  such  transportation,  to  be  paid  by  the 
consignor. 

No  such  parcel  or  package  shall  be  transported  until  a 
stamp  or  stamps  representing  the  tax  due  shall  have 
been  affixed  thereto. 

Approved  by  the  President,  October  3,  1917. 

1  This  tax  is  two  cents  upon  every  pack. 


CHAPTER  XXVII 

WAR  TAX  ON  PUBLIC  UTILITIES 
AND  INSURANCE 

What  is  taxed.— Sections  500  to  505,  Title  V,  of  the 
Act  of  October  3,  1917,  provide  for  a  tax  on  and  after 
November  1,  1917,  npon  payments  made  for  domestic 
freight,  express  and  passenger  transportation;  trans- 
portation of  oil  by  pipe  line;  telegraph,  telephone  and 
radio  messages;  life  insurance;  marine,  inland  and  fire 
insurance,  and  other  insurance  policies. 

Transportation  denned. — The  definition  of  "transpor- 
tation" in  its  relation  to  the  business  of  common  car- 
riers contained  in  the  Interstate  Commerce  Act  of  June 
29,  1906  (34  Stat.  584),  is  held  to  apply  to  that  term 
as  used  in  section  500  of  the  Act  of  October  3,  1917, 
and  is  as  follows: 

"The  term  transportation  shall  include  cars  and 
other  vehicles  and  all  instrumentalities  and  facilities  of 
shipment  or  carriage,  irrespective  of  ownership  or  of 
any  contract  express  or  implied,  for  the  use  thereof  and 
all  services  in  connection  with  the  receipt,  delivery, 
elevation,  and  transfer  in  transit,  ventilation,  refrig- 
eration or  icing,  storage  and  handling  of  property 
transported." 

Who  pays  the  tax. — The  tax,  in  the  case  of  the  various 
charges  for  transportation  and  messages,  is  added  to 
the  regular  charges  and  is  paid  by  the  public.  In  the 
case  of  insurance,  the  tax  is  intended  to  be  borne  by  the 
insurance  companies  and  not  added  to  the  amount  of 
the  premiums. 

575 


576  INCOME   AND    FEDERAL    TAX    REPORTS 

While,  in  the  case  of  the  tax  on  transportation,  the 
person  or  company  rendering  the  service  is  charged 
with  the  duty  of  collecting  the  tax  and  making  proper 
returns  and  payment  to  the  collector,  in  a  Treasury  de- 
cision of  December  1,  1917,  it  is  held  that  passengers 
purchasing  tickets,  if  they  neglect  to  pay  the  tax,  are 
liable  to  the  penalties,  as  well  as  the  carriers.  The 
penalty  provided  is  a  fine  of  not  over  $1,000  or  impris- 
onment for  not  exceeding  one  year.  This  decision  was 
made  necessary  by  the  laxity  as  to  payment,  in  the 
early  period  of  the  incidence  of  the  tax. 

Exemptions  relating  to  transportation  and  messages. — It 
is  provided  in  section  502  "that  no  tax  shall  be  im- 
posed under  section  five  hundred  upon  any  payment 
received  for  services  rendered  to  the  United  States,  or 
any  State,  territory,  or  the  District  of  Columbia.  The 
right  to  exemption  under  this  section  shall  be  evidenced 
in  such  manner  as  the  Commissioner  of  Internal  Rev- 
enue, with  the  approval  of  the  Secretary  of  the  Treas- 
ury, may  by  regulation  prescribe." 

The  foregoing  is  held  to  apply  also  to  political  sub- 
divisions of  States  and  Territories.  Specific  exemp- 
tions include  all  institutions  maintained  solely  for  the 
exercise  of  legitimate  governmental  functions,  such  as 
State  colleges,  public  libraries,  hospitals,  etc. 

The  Food  Administration  Grain  Corporation,  Federal 
Farm  Loan  Board,  Federal  land  banks,  farm  loan  reg- 
isters, land  bank  examiners,  and  land  bank  appraisers 
are  exempt  from  tax  under  this  section,  when  exercis- 
ing strictly  governmental  functions. 

Decisions  of  the  Treasury  Department  with  regard  to 
specific  conditions  will  be  quoted  or  referred  to  under 
the  sections  below,  relating  to  freight,  express  and  pas- 
senger transportation. 

Definitions  relating  to  transportation. — The  term  "United 
States,"  as  used  in  section  500  in  the  phrase  "from  one 
point   in   the   United    States   to    another,"   means   the 


WAR    TAX   ON   PUBLIC    UTILITIES  577 

States,  Territories  of  Alaska  and  Hawaii,  and  the  Dis- 
trict of  Columbia. 

The  phrase  "for  less  than  30  miles"  means  for  less 
than  30  constructive  miles  in  instances  where  two  or 
more  carriers  are  competing  for  transportation  services. 

"Commutation  or  season  tickets"  include  all  tickets 
issued  to  and  intended  for  the  use  of  the  purchaser  for 
a  certain  number  of  trips  between  two  given  termini, 
whether  limited  or  unlimited  as  to  the  time  in  which 
they  are  to  be  used.  Commutation  or  season  tickets  do 
not  include  party  tickets. 

Freight. — The  tax  on  freight  charges,  paid  by  ship- 
pers, is  3  per  cent  of  the  amount  paid  for  the  transpor- 
tation by  rail  or  water  or  by  any  form  of  mechanical 
motor  power  when  in  competition  with  carriers  by  rail 
or  water  of  property  by  freight  consigned  from  one  point 
in  the  United  States  to  another.  Ferry  charges  are  in- 
cluded. 

Carriers  transporting  their  own  commodities,  except 
such  commodities  as  are  necessary  for  use  in  their 
business  as  carriers,  are  required  to  pay  a  tax  equal 
to  that  which  would  have  accrued  if  the  service  had 
been  paid  for.  No  tax  accrues,  however,  for  transpor- 
tation by  a  carrier  of  a  commodity  necessary  and  in- 
tended to  be  used  in  the  conduct  of  its  business  as  such; 
neither  is  any  tax  imposed  in  a  case  where  such  a  com- 
modity is  transported  for  the  similar  use  of  another 
carrier  which  is  a  part  of  the  same  "system." 

Government  exemptions. — The  following  are  Treas- 
ury decisions  relating  to  cases  in  which  transportation 
is  for  services  rendered  to  the  Government: 

All  shipments  either  by  freight  or  express,  the 
charges  on  which  are  paid  directly  by  the  United 
States,  will  be  free  of  the  tax  imposed  by  section  500. 
Shipments  of  Government  property  by  Government  offi- 
cers will  be  made  on  Government  bills  of  lading. 

Shipments  of  property  belonging  to  a  State,  Terri- 


578  INCOME   AND    FEDERAL    TAX    REPORTS 

tory,  or  the  District  of  Columbia,  the  charges  on  which 
are  paid  by  the  State,  Territory  or  the  District  of  Co- 
lumbia, will  be  made  free  of  the  tax  imposed  by  sec- 
tion 500.  The  words  "State"  and  "Territory"  are  held 
to  include  the  political  subdivisions  thereof. 

It  will  be  necessary  in  all  cases  of  shipments  made 
by  freight  or  express,  where  Government  bills  of  lading 
are  not  used,  for  the  officer  or  employee  of  the  United 
States,  State,  Territory,  or  the  District  of  Columbia,  to 
satisfy  the  agent  to  whom  the  charges  are  paid  that  the 
service  rendered  or  to  be  rendered  is  for  the  United 
States,  State,  Territory,  or  the  District  of  Columbia, 
as  the  case  may  be,  and  the  agent  collecting  the  charges 
should  note  on  the  records  of  his  office  the  name  of  the 
consignor  and  consignee,  and  indicate  thereon  that  such 
shipment  covered  service  rendered  the  United  States, 
State,  Territory,  or  the  District  of  Columbia,  as  the  case 
may  be,  and  was  not  subject  to  the  tax. 

Shipments  by  freight  or  express  of  property  received 
by  the  United  States,  or  any  State,  Territory,  or  the 
District  of  Columbia,  are  free  of  the  transportation  tax, 
provided  the  United  States  or  any  State,  Territory,  or 
the  District  of  Columbia  is  liable  for  and  pays  the 
transportation  charges  on  such  shipments. 

Miscellaneous  Treasury  decisions.  —  In  all  cases  in 
which  shippers  have  credit  arrangements  with  carriers 
under  which  their  goods  are  shipped  prepaid  but  the 
freight  charges  were  not  actually  paid  until  after  No- 
vember 1,  1917,  the  tax  is  not  imposed  on  amounts  paid 
for  such  transportation  begun  prior  to  November  1, 
1917. 

If  the  consignees  have  credit  arrangements  with  car- 
riers under  which  they  settle  their  freight  bills  on  or 
before  the  15th  of  the  month,  the  tax  is  not  imposed 
or  charged  on  freight  bills  for  the  transportation  of 
goods  actually  delivered  prior  to  November  1,  1917. 

No  tax  is  imposed  upon  amounts  paid  for  transporta- 


WAR    TAX   ON   PUBLIC    UTILITIES  579 

tion  of  goods  by  freight  in  any  instance  in  which  the 
property  was  actually  delivered  to  the  consignee  prior 
to  November  1,  1917,  and  by  reason  of  the  loss  of  the 
bill  of  lading,  dispute  as  to  the  amount  of  charges,  or 
other  delay,  the  payment  was  not  made  at  the  time  of 
delivery. 

No  tax  is  imposed  on  the  amount  paid  for  transpor- 
tation on  a  through  bill  of  lading  to  or  from  Canada  or 
Mexico  or  any  foreign  country.  If  however,  property  is 
shipped  by  freight  from  a  point  in  the  United  States  to 
a  seaport  on  one  bill  of  lading  and  is  then  reconsigned 
for  export,  the  tax  is  imposed  on  the  amount  paid  for 
the  transportation  to  the  seaport. 

Goods  which  are  imported  into  the  United  States  and 
reconsigned  at  port  of  entry  to  a  point  in  the  United 
States  are  subject  to  the  tax  upon  the  amount  paid  for 
transportation  from. the  port  of  entry  to  destination  in 
the  United  States.  If  the  property  is  consigned  from 
a  foreign  port  to  a  point  within  the  United  States  with- 
out being  reconsigned  at  the  port  of  entry,  the  tax  is 
not  to  be  imposed. 

A  railroad  transporting  a  circus  train  should  appor- 
tion the  charges  for  the  service  rendered  between  the 
freight  and  passenger  service,  and  the  tax  imposed  by 
subdivision  (a)  of  section  500  should  be  collected  in  the 
case  of  the  former,  and  the  8  per  cent  tax  imposed  by 
subdivision  (c)  of  said  section  should  be  collected  in  the 
case  of  the  latter. 

Where  the  charge  for  transportation  includes  the 
charge  for  lighterage,  which  service  is  performed  on  or 
after  November  1,  1917,  the  tax  collected  on  or  after 
that  date  should  be  based  upon  the  entire  charge  for 
transportation. 

Logging  companies  which  do  a  carrier  business  are 
subject  to  the  tax  imposed  by  section  500  upon  the 
transportation  of  commodities  owned  by  them  which  are 
not  necessary  for  their  use  in  the  conduct   of  their 


580  INCOME   AND    FEDERAL    TAX   REPORTS 

business  as  carriers  and  are  not  intended  to  be  so  used 
or  have  not  been  so  used. 

Where  a  railroad  company  carries  materials  for  a 
telegraph  company  free  in  consideration  of  messages 
sent  free  over  the  lines  of  the  telegraph  company,  the 
tax  attaches  upon  the  amounts  which  the  railroad  com- 
pany and  the  telegraph  company  would  otherwise  re- 
ceive for  services  performed  but  for  the  comity  of  rela- 
tions between  them. 

Tax  attaches  upon  the  amount  paid  for  transporta- 
tion of  goods  from  one  pier  to  another  in  the  same 
harbor. 

Tax  does  not  attach  separately  on  the  following  mis- 
cellaneous services  rendered  by  a  carrier  when  the 
charge  for  such  services  is  included  and  paid  in  the 
through  tariff  rate  for  the  road  haul:  (a)  switching  and 
drayage;  (b)  wharfage,  storage  and  lighterage;  (c) 
compressing  in  transit;  (d)  milling  in  transit;  (e)  dress- 
ing and  refining  in  transit;  (f)  diversion  and  recon- 
signing  charges;  (g)  refrigeration;  (h)  car  service; 
(i)  demurrage;  (j)  charge  for  consigning  freight  to 
order  notify;  (k)  storage;  (1)  car  rental;  (m)  switch 
charges  for  return  of  empty  cars  over  belt  or  switch- 
ing lines;  (n)  weighing  charges;  (o)  feeding  and  water- 
ing stock  in  transit. 

However,  if  the  through  tariff  rate  does  not  include 
such  services,  the  amounts  paid  for  the  same  are  tax- 
able if  such  services  are  a  part  of  the  transportation  by 
the  carrier. 

In  instances  in  which  the  amount  paid  for  transpor- 
tation by  freight  is  a  lump  sum  the  tax  should  be  im- 
posed upon  such  sum  without  regard  to  the  individual 
items  which  make  up  the  total.  In  computing  the  tax, 
a  fraction  of  a  cent  should  be  disregarded  unless  it 
amounts  to  one  half  cent  or  more,  in  which  case  it 
should  be  increased  to  1  cent. 

When  property  is  transported  part  of  the  way  by 


WAR    TAX   ON   PUBLIC    UTILITIES  581 

freight  and  part  of  the  way  by  express  the  tax  will  be 
3  per  cent  on  the  amount  paid  for  the  freight  move- 
ment and  1  cent  for  each  20  cents  or  fraction  paid  for 
the  movement  by  express. 

Express. — The  tax  on  express  charges  is  "1  cent  for 
each  20  cents  or  fraction  thereof  paid  to  any  person, 
corporation,  partnership  or  association,  engaged  in  the 
business  of  transporting  parcels  or  packages  by  ex- 
press over  regular  routes  between  fixed  terminals,  for 
the  transportation  of  any  package,  parcel  or  shipment 
by  express  from  one  point  within  the  United  States  to 
another." 

The  tax  is  to  be  paid  by  the  shipper. 

Exemptions. — The  exemptions  in  favor  of  the  Gov- 
ernment and  States  set  forth  above  under  "Freight"  ap- 
ply also  to  shipments  by  express. 

Separate  items  of  a  shipment  need  not  be  listed. — 
The  question  as  to  whether  or  not  under  paragraph 
(b),  section  500,  newspapers  or  similar  articles  shipped 
by  express  shall  be  accounted  for  for  taxing  purposes 
in  separate  packages  or  in  bulk  shipments  is  answered 
in  the  following  Treasury  decision: 

From  the  facts  presented  it  appears  that  the  method  of  transporting 
newspapers  by  express  is  to  deliver  to  the  express  company  in  bulk,  tied 
or  fastened  together,  an  entire  shipment,  and  to  base  and  pay  the  express 
charges  thereon  without  regard  to  enclosed  subdivisions  to  be  thrown  off  or 
delivered  at  way  stations;  that  is  to  say:  if  500  pounds  of  newspapers 
should  be  shipped  on  a  single  car  at  one  time,  to  be  distributed  at  10  dif- 
ferent stations,  the  package  would  be  received  as  one  shipment  and  the 
total  express  charge  would  be  for  the  aggregate  amounts  of  the  10  sub- 
divisions, and  not  upon  the  basis  of  the  10  deliveries. 

As  this  was  a  fact  and  a  commercial  condition  at  the  time  of  the  pas- 
sage of  the  Act,  Congress  is  assumed,  if  the  contrary  does  not  otherwise 
appear  in  the  law,  to  have  enacted  the  taxing  provision  relative  to  express 
shipments  in  view  of  and  to  meet  such  existing  commercial  conditions  and 
practice. 

It  will  be  observed  that  the  tax  is  laid  upon  the  transportation  of  "any 
package,  parcel,  or  shipment  by  express  from  one  point  in  the  United  States 
to  another." 

These  shipments,  as  indicated  in  the  above  example,  would  be  from  one 
point  to  10  different  points,  and  a  literal  interpretation  of  the  law,  taken 


582  INCOME   AND    FEDERAL    TAX    REPORTS 

in  connection  with  the  use  of  the  words  "package,  parcel  or  shipment,'* 
might  require  the  payment  of  this  tax  upon  the  parcel,  or  separate  deliv- 
ery basis. 

This  seems  to  have  been  in  the  mind  of  Congress  at  the  time  of  the  en- 
actment of  the  law,  but  the  proviso  immediately  following  was  doubtless 
intended  to  cure  the  difficulties  or  delays  that  might  arise  out  of  the  lit- 
eral interpretation  of  the  language  used.    That  proviso  reads  as  follows: 

Provided:  That  nothing  herein  contained  shall  be  construed  to  require 
the  carrier  collecting  such  tax  to  list  separately  in  any  bill  of  lading, 
freight  receipt,  or  similar  document,  the  amount  of  the  tax  herein  levied, 
if  the  total  amount  of  the  freight  and  tax  be  therein  stated. 

It  is  manifest  from  the  foregoing  that  it  will  not  be  necessary  to  specify 
in  each  express  receipt  the  separate  parcels  marked  with  the  name  of  the 
point  of  delivery  or  to  pay  the  tax  upon  that  basis,  if  the  total  amount 
paid  for  transportation  of  the  entire  shipment  and  the  tax  due  and  paid 
be  stated  in  such  receipt. 

All  transportation  of  milk  and  cream  by  express  com- 
panies is  "by  express"  and  is  taxable  as  such.  If  trans- 
portation is  by  trolley  line  the  classification  employed 
by  the  trolley  line  as  "by  freight"  or  "by  express"  will 
govern,  and  the  tax  will  be  imposed  accordingly. 

Charges  for  delivery  of  packages  by  horse-drawn  ve- 
hicles will  not  be  included  in  the  taxable  express 
charges,  since  the  tax  applies  only  to  transportation  by 
mechanical  motor  power. 

Passenger  transportation. — The  tax  on  passenger  trans- 
portation is  8  per  cent  of  the  fare  (except  where  fare 
is  35  cents  or  less  or  where  season  or  commutation 
tickets  are  used  for  trips  of  less  than  30  miles),  pay- 
able by  the  passenger,  although  the  tax  return  and 
actual  payment  to  the  collector  is  made  by  the  carrier. 
The  transportation  so  taxable  is,  as  in  the  case  of 
freight  and  express  transportation,  that  which  is  over 
a  regularly  established  line,  rail  or  by  water,  in  com- 
petition with  other  carriers.  Automobile  carriers  oper- 
ating on  a  regularly  established  route  are  included  in 
cases  where  the  fare  is  over  35  cents. 

The  tax  attaches  in  each  case  where  the  distance  trav- 
eled in  a  continuous  journey  is  30  miles  or  more,  or 
where  the  total  fare  is  35  cents  or  more.     Bound-trip 


WAR    TAX   ON   PUBLIC    UTILITIES  583 

tickets  costing  70  cents  or  more  are  taxable.  The  tax 
is  to  be  collected  pro  rata  in  cases  where  the  fare  is 
collected  in  amounts  of  less  than  35  cents,  as  some- 
times happens  in  the  "zone"  system.  The  tax  is  col- 
lectible notwithstanding  the  passenger  may  pay  cash 
for  part  of  the  transportation  and  give  commutation 
tickets  for  another  part. 

In  the  case  of  passenger  transportation,  the  tax  ap- 
plies not  only  to  points  within  the  United  States,  but 
also  to  transportation  to  Canada  or  Mexico,  if  the  tick- 
ets therefor  are  sold  and  issued  in  the  United  States. 

Pullmcm  berths,  staterooms,  etc. — There  is  also  a  tax 
of  10  per  cent  for  seats,  berths,  and  staterooms  in  par- 
lor cars,  sleeping  cars,  or  on  vessels.  Where  the  price 
of  the  ticket  includes  charges  for  berth,  stateroom  and 
meals,  which  cannot  be  segregated,  a  tax  of  only  8  per 
cent  of  the  amount  paid  for  the  ticket  is  collectible. 

Exemptions. — Exemptions  in  favor  of  the  Government 
are  described  in  the  Treasury  decisions  given  below: 

When  officers  or  employees  of  the  United  States,  or 
of  any  State,  Territory,  or  the  District  of  Columbia, 
travel  on  transportation  requests,  the  transportation  re- 
quests will  be  sufficient  evidence  that  the  tickets  ob- 
tained thereon  either  for  transportation  by  rail  or 
water,  or  for  seats,  berths,  or  staterooms  in  parlor  cars, 
sleeping  cars  or  on  vessels,  were  received  from  the 
agent  without  the  payment  of  tax  imposed  by  section 
500. 

The  agent  of  the  transportation  company  who  issues 
the  ticket  should  note  on  the  records  of  his  office  the 
number  of  the  Government  transportation  request. 
Where  travel  is  made  by  officers  or  employees  of  a 
State,  Territory,  or  the  District  of  Columbia,  upon 
transportation  requests,  a  notation  should  be  made  on 
the  records  of  the  agent  issuing  the  ticket  so  that  a 
verification  can  be  made,  as  in  case  of  Government 
transportation  requests. 


584  INCOME   AND    FEDERAL    TAX    REPORTS 

When  an  officer  or  employee  of  the  United  States,  or 
of  a  State,  Territory,  or  the  District  of  Columbia,  is 
traveling  on  official  business  and  pays  cash  for  his 
transportation,  or  presents  a  mileage  book  purchased 
prior  to  November  1,  1917,  he  will  give  to  the  agent 
from  whom  tickets  are  obtained  for  transportation  by 
rail,  or  water,  or  vessels,  or  the  conductor  or  agent  to 
whom  he  presents  the  mileage  book,  his  certificate  stat- 
ing that  the  service  to  be  rendered  from  the  place 
named  is  on  account  of  official  business  and  not  for 
private  purposes.  Transportation  agents  should  not 
accept  such  certificate  unless  the  officer  or  employee 
presenting  same   shows   satisfactory  credentials. 

In  case  a  ticket,  obtained  either  on  a  transportation 
request  or  by  purchase  and  not  partially  used  prior  to 
November  1,  1917,  is  presented  for  travel  on  official 
business  on  or  after  November  1,  1917,  a  certificate 
made  in  the  form  indicated  above  should  be  given  to 
the  conductor  to  whom  such  ticket  is  first  presented. 

Commutation,  season,  and  party  tickets. — "Commuta- 
tion or  season  tickets"  include  all  tickets  issued  to  and 
intended  for  the  use  of  the  purchaser  for  a  certain  num- 
ber of  trips  between  two  given  termini,  whether  lim- 
ited or  unlimited  as  to  the  time  in  which  they  are  to  be 
used;  commutation  or  season  tickets  do  not  include 
party  tickets.  The  tax  must  be  paid  on  such  tickets  at 
the  time  of  purchase,  where  the  length  of  the  specified 
journeys  is  30  miles  or  more,  or  the  fare  for  each  jour- 
ney is  35  cents  or  more. 

Mileage  books.  —  A  mileage  book  purchased  on  or 
after  November  1,  1917,  is  subject  to  tax  upon  the  full 
purchase  price  at  the  time  of  purchase;  where  a  mile- 
age book  purchased  prior  to  November  1,  1917,  is  used 
on  or  after  that  date,  the  person  presenting  such  book, 
whether  the  transportation  fare  to  be  used  is  more  or 
less  than  35  cents,  must  pay  to  the  conductor  or  other 
agent  the  tax  on  such  proportionate  amount  of  the  cost 


WAR    TAX   ON   PUBLIC    UTILITIES  585 

of  the  book  as  the  unused  mileage  bears  to  the  total 
mileage  originally  in  the  book. 

Baggage. — Amount  paid  for  transportation  of  excess 
baggage  is  held  to  be  part  and  parcel  of  the  amount 
paid  for  transportation  of  persons  and  is  therefore  sub- 
ject to  tax  at  a  like  rate;  no  tax  is  imposed  under  the 
Act  of  October  3,  1917,  on  amounts  paid  for  the  storage 
of  baggage. 

Through  transportation. — Where  through  transporta- 
tion is  paid  in  full,  for  example,  from  New  York  to 
Hongkong  by  way  of  Vancouver,  British  Columbia,  the 
railway  ticket  from  New  York  to  Vancouver  would  be 
subject  to  tax  under  section  500,  and  the  steamship 
ticket  from  Vancouver  to  Hongkong  would  be  subject 
to  the  tax  imposed  on  passage  tickets. 

A  through  ticket  purchased  in  Hongkong  for  Habana, 
Cuba,  routed  trans-Pacific  steamer  to  San  Francisco, 
rail  lines  thence  to  New  Orleans,  and  steamship  line 
thence  to  Habana,  the  ticket  containing  an  order  "Good 
for  exchange  in  San  Francisco  for  a  railroad  ticket 
from  San  Francisco  to  New  Orleans,  and  in  New  Or- 
leans for  a  steamship  ticket  from  New  Orleans  to  Ha- 
bana," is  subject  to  the  tax  imposed  by  subdivision  (c) 
of  section  500  on  the  amount  paid  for  the  transporta- 
tion from  San  Francisco  to  New  Orleans,  and  to  the 
tax  imposed  .by  paragraph  (10) 1  of  Schedule  A,  Title 
VIII,  of  the  Act  of  October  3,  1917,  on  amounts  paid 
for  transportation  from  New  Oreans  to  Habana,  Cuba- 
Corpses. — Where  a  corpse  is  transported  under  tariffs 
requiring  one  first-class  ticket  therefor  and  one  first- 
class  ticket  for  an  attendant,  under  the  carrier's  regu- 
lations, the  tax  is  imposed  as  in  the  case  of  passenger 
transportation  on  both  tickets ;  where  a  corpse  is  trans- 
ported by  freight  or  express,  the  amount  paid  for  such 
transportation  would  be  subject  to  the  tax  imposed  in 
the  case  of  freight  or  express  transportation. 

i  Passage  Tickets  for  Foreign  Ports. 


586  INCOME   AND   FEDERAL   TAX   REPORTS 

Telegraph,  telephone  and  radio  messages. — A  tax  of 
5  cents  for  each  such  message  is  imposed,  payable  by 
the  sender  on  each  such  message  originating  within  the 
United  States  and  for  the  transmission  of  which  a 
charge  of  15  cents  or  more  is  made. 

Only  one  tax  is  imposed,  notwithstanding  the  lines  or 
stations  of  more  than  one  concern  be  used  for  trans- 
mission. 

Exemptions. — All  telegraph,  telephone  or  radio  mes- 
sages of  officers  and  employees  of  the  United  States,  or 
of  a  State,  Territory,  or  the  District  of  Columbia,  or 
political  subdivision  thereof,  on  official  business,  are 
exempt  from  tax,  and  should  not  be  reported  in  the 
monthly  return  of  the  telegraph,  telephone  or  radio  com- 
pany. Such  messages,  conversations  and  dispatches,  to 
be  exempt,  must  not  only  relate  to  Government  business 
but  must  be  a  charge  against  and  actually  be  paid  for 
out  of  Government  funds.  In  case  of  a  telegraph  or 
radio  message,  the  officer  or  employee  sending  such  mes- 
sage should  certify  thereon  that  it  is  on  account  of  offi- 
cial business  and  not  for  private  purposes.  This  cer- 
tificate may  be  in  the  following  form: 

"I  certify  that  this  message  is  on  official  business  and 
not  for  private  purposes. 


(Title)." 


Oil  pipe-lines. — A  tax  of  5  per  cent  is  imposed  on  all 
charges  for  transportation  of  oil  by  pipe-line. 

Returns. — Returns  on  all  the  taxes  mentioned  above 
are  required  monthly  in  duplicate,  as  provided  in  sec- 
tion 503.  The  first  return  is  due  on  or  before  Feb- 
ruary 28,  1918,  covering  the  month  of  November,  1917. 
Returns  for  each  month  thereafter  must  be  made  and 
tax  paid  over  on  or  before  three  months  from  the  last 
day  of  the  month  covered  by  the  return. 


WAR    TAX   ON   PUBLIC    UTILITIES  587 

Penalties. — The  penalty  for  failure  to  comply  with 
the  provisions  of  section  500  is  a  fine  of  not  more  than 
$1,000  or  imprisonment  for  not  more  than  one  year,  or 
both.  The  penalty  is  imposed  not  only  upon  the  person 
or  corporation  required  to  make  the  return  and  pay 
over  the  tax,  but  also  upon  the  person  failing  to  pay 
the  tax  at  the  time  he  pays  the  transportation  charges. 

Insurance. — The  taxes  imposed  upon  the  various  forms 
of  insurance  effective  November  1,  1917,  are  as  follows, 
no  policies  of  reinsurance  *  being  taxable : 

(a)  Life  insurance. — The  tax  imposed  on  life  insur- 
ance policies  is  8  cents  on  each  $100  or  fractional  part 
thereof  of  the  amount  for  which  any  life  is  insured 
under  any  form  of  policy,  except  policies  issued  by 
persons,  corporations,  partnerships  or  associations  whose 
income  is  exempt  from  taxation  under  Title  I  of  the 
Act  of  September  8,  1916. 

Life  insurance  policies  for  an  amount  not  in  excess 
of  $500  and  issued  on  the  industrial  or  weekly  payment 
plan  are  taxed  at  the  rate  of  40  per  cent  of  the  amount 
of  the  first  weekly  premium. 

The  tax  does  not  apply  to  Soldiers'  and  Sailors'  In- 
surance written  by  the  War  Eisk  Bureau. 

(b)  Marine,  inland  and  fire  insurance. — The  tax  on 
policies  of  property  insurance  of  any  description  (in- 
cluding rents  and  profits)  made  or  renewed  on  or  after 
November  1,  1917,  is  at  the  rate  of  1  cent  on  every  dol- 
lar or  fractional  part  thereof  of  the  premium  charged. 

(c)  Casualty  insurance. — The  tax  on  casualty  insur- 
ance policies- is  1  cent  on  each  dollar  or  fractional  part 
thereof  of  the  premium  charged. 

Companies  insuring  or  guaranteeing  any  loss  that 
might  be  occasioned  by  reason  of  accepting  mortgages 
that  cannot  be  foreclosed  or  in  any  manner  recovered 
upon  are  subject  to  tax  under  paragraph  (c). 

i  Reinsurance  is  the  underwriting  of  part  of  the  liability  of  one  company 
by  another  company. 


588  INCOME   AND    FEDERAL    TAX    REPORTS 

Associations  composed  of  employers  or  others  who 
band  themselves  together  for  mutual  protection  in  is- 
suing life  and  casualty  insurance  are  subject  to  tax 
under  paragraph  (c)  unless  exempted  from  income  tax 
under  Title  I  of  the  Act  of  September  8,  1916,  and  as 
amended. 

If  mutual  fire  or  tornado  insurance  companies  are  ex- 
empt under  the  income  tax  law,  no  tax  is  imposed  by 
this  Act.    Said  Income  Tax  Law  is,  in  part,  as  follows: 

"Farmers'  or  other  mutual,  hail,  cyclone,  or  fire  in- 
surance company  *  *  *  or  organization  of  a  purely 
local  character,  the  income  of  which  consists  solely  of 
assessments,  dues,  and  fees  collected  from  members 
for  the  sole  purpose  of  meeting  expenses." 

Insurance  policies  issued  by  organizations  of  the  above 
description  are  exempt. 

Miscellaneous  Treasury  decisions. — Brokers  who  place 
risks  for  clients  with  insurance  companies  are  not  sub- 
ject to  tax  under  section  504  (War  Tax  on  Insurance 
Policies),  as  the  tax  is  imposed  upon  the  companies 
issuing  the  insurance. 

No  tax  on  insurance  is  imposed  on  the  insured.  The 
tax  is  imposed  by  section  504  upon  the  person,  firm, 
or  corporation  writing  the  insurance,  the  necessary  re- 
turns for  which  will  be  rendered  to  the  collector  of  the 
district  in  which  the  principal  place  of  business  is  lo- 
cated. The  tax  is  imposed  on  newly  written  policies 
and  on  premiums  paid  on  "open"  policies,  but  not  on 
amounts  paid  on  policies  of  reinsurance.  Consequently, 
where  an  insurance  company  reinsures  the  risks  of  an- 
other company  the  transaction  is  termed  reinsurance, 
and  would  not  be  taxable.  The  tax  is  imposed  on  in- 
surance without  regard  to  sex  or  age  of  the  insured. 

Reinsurance  is  regarded  as  that  insurance  taken  out 
by  a  company  which  has  overinsured  and  obtained  an- 
other company  to  underwrite  for  it  a  part  of  the  lia- 
bility. 


WAR    TAX   ON   PUBLIC    UTILITIES  589 

Tax  accrues  on  insurance  policies  issued  within  the 
United  States,  irrespective  of  the  residence  of  the  in- 
sured. 

Tax  under  section  504  is  imposed  on  the  premium 
charged,  each  separate  premium  collected  being  re- 
garded as  a  separate  item  for  the  computation  of  the 
tax,  and  not  on  the  gross  amount  of  the  premiums  col- 
lected for  any  one  month. 

So  far  as  the  tax  is  concerned,  the  issuance  of  a  pol- 
icy is  considered  to  be  of  the  date  when  the  policy  is 
delivered  to  the  insured  or  in  any  other  manner  becomes 
a  valid  claim  and  effective  for  insurance. 

Returns. — Eeturn  for  tax  on  insurance  may  be  filed 
either  direct  from  the  home  office,  or  by  the  State  or 
district  superintendent  or  agent,  where  such  is  ap- 
pointed or  employed.  Such  State  or  territorial  agents 
should  be  given  authority,  in  writing,  from  the  main 
office,  to  make  such  returns  and  account  for  the  tax  due 
on  policies  written.  Single  reports,  prepared  by  home 
offices,  however,  are  preferred.  Local  insurance  agents 
will  not  be  required  to  make  returns. 

Blank  forms  of  returns  required  by  section  505  will 
be  furnished  to  insurance  companies  monthly  by  the 
Commissioner  of  Internal  Kevenue. 

Eeturns  showing  the  name  and  address  of  each  per- 
son to  whom  an  indemnity  is  paid  are  not  required. 

Permission  will  be  granted  to  take  credit  in  a  sub- 
sequent month's  report  for  any  overpayment  of  tax  for 
a  prior  month. 

The  first  return  was  due  December  15,  1917,  covering 
the  month  of  November.  Each  return  must  be  made  on 
or  before  the  15th  day  of  each  month,  covering  all  poli- 
cies issued  during  the  preceding  month. 


CHAPTER  XXVIII 

WAR  TAX  ON  UTILITIES  AND 
INSURANCE  LAW 

BEING  TITLE  V  OF  "AN  ACT  TO  PROVIDE  REVENUE 

TO  DEFRAY  WAR  EXPENSES,  AND  FOR  OTHER 

PURPOSES,"  APPROVED  OCTOBER  3,   1917. 

(PUBLIC— No.  50— 65th  CONGRESS.)     IN 

EFFECT  OCTOBER  4,  1917,  UNLESS 

OTHERWISE  SPECIALLY 

PROVIDED. 


TITLE  V.— WAR  TAX  ON  FACILITIES  FURNISHED  BY 
PUBLIC  UTILITIES,  AND  INSURANCE. 

Freight  and  express  shipments,  passenger  traffic,  etc. — 
Sec.  500  [of  the  general  revenue  Act  of  which  this  Title 
is  a  part].  That  from  and  after  the  first  day  of  No- 
vember, nineteen  hundred  and  seventeen,  there  shall  be 
levied,  assessed,  collected,  and  paid  (a)  a  tax  equivalent 
to  three  per  centum  of  the  amount  paid  for  the  trans- 
portation by  rail  or  water  or  by  any  form  of  mechanical 
motor  power  when  in  competition  with  carriers  by  rail 
or  water  of  property  by  freight  consigned  from  one 
point  in  the  United  States  to  another;  (b)  a  tax  of  1 
cent  for  each  20  cents,  or  fraction  thereof,  paid  to  any 
person,  corporation,  partnership,  or  association,  en- 
gaged in  the  business  of  transporting  parcels  or  pack- 
ages by  express  over  regular  routes  between  fixed  ter- 
minals, for  the  transportation  of  any  package,  parcel,  or 
shipment  by  express  from  one  poiflt  in  the  United  States 

590 


WAR   TAX   ON    UTILITIES  591 

to  another:  Provided,  That  nothing  herein  contained 
shall  be  construed  to  require  the  carrier  collecting  such 
tax  to  list  separately  in  any  bill  of  lading,  freight  re- 
ceipt, or  other  similar  document,  the  amount  of  the  tax 
herein  levied,  if  the  total  amount  of  the  freight  and  tax 
be  therein  stated;  (c)  a  tax  equivalent  to  eight  per  cen- 
tum of  the  amount  paid  for  the  transportation  of  per- 
sons by  rail  or  water,  or  by  any  form  of  mechanical  motor 
power  on  a  regular  established  line  when  in  competition 
with  carriers  by  rail  or  water,  from  one  point  in  the 
United  States  to  another  or  to  any  point  in  Canada  or 
Mexico,  where  the  ticket  therefor  is  sold  or  issued  in 
the  United  States,  not  including  the  amount  paid  for 
commutation  or  season  tickets  for  trips  less  than  thirty 
miles,  or  for  transportation  the  fare  for  which  does  not 
exceed  35  cents,  and  a  tax  equivalent  to  ten  per  centum 
of  the  amount  paid  for  seats,  berths,  and  staterooms  in 
parlor  cars,  sleeping  cars,  or  on  vessels.  If  a  mileage 
book  used  for  such  transportation  or  accommodation 
has  been  purchased  before  this  section  takes  effect,  or 
if  cash  fare  be  paid,  the  tax  imposed  by  this  section  shall 
be  collected  from  the  person  presenting  the  mileage 
book,  or  paying  the  cash  fare,  by  the  conductor  or  other 
agent,  when  presented  for  such  transportation  or  ac- 
commodation, and  the  amount  so  collected  shall  be  paid 
to  the  United  States  in  such  manner  and  at  such  times 
as  the  Commissioner  of  Internal  Kevenue,  with  the  ap- 
proval of  the  Secretary  of  the  Treasury,  may  prescribe ; 
if  a  ticket  (other  than  a  mileage  book)  is  bought  and 
partly  used  before  this  section  goes  into  effect  it  shall 
not  be  taxed,  but  if  bought  but  not  so  used  before  this 
section  takes  effect,  it  shall  not  be  valid  for  passage  until 
the  tax  has  been  paid  and  such  payment  evidenced  on 
the  ticket  in  such  manner  as  the  Commissioner  of  In- 
ternal Eevenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  may  by  regulation  prescribe;  (d)  a  tax 
equivalent  to  five  per  centum  of  the  amount  paid  for  the 


592  INCOME   AND    FEDERAL    TAX   REPORTS 

transportation  of  oil  by  pipe  line;  (e)  a  tax  of  5  cents 
upon  each  telegraph,  telephone,  or  radio,  dispatch,  mes- 
sage, or  conversation,  which  originates  within  the  United 
States,  and  for  the  transmission  of  which  a  charge  of 
15  cents  or  more  is  imposed:  Provided,  That  only  one 
payment  of  such  tax  shall  be  required,  notwithstanding 
the  lines  or  stations  of  one  or  more  persons,  corpora- 
tions, partnerships,  or  associations  shall  be  used  for  the 
transmission  of  such  dispatch,  message,  or  conversation. 

Sec.  501.  That  the  taxes  imposed  by  section  five  hun- 
dred shall  be  paid  by  the  person,  corporation,  partner- 
ship, or  association  paying  for  the  services  or  facilities 
rendered. 

In  case  such  carrier  does  not,  because  of  its  ownership 
of  the  commodity  transported,  or  for  any  other  reason, 
receive  the  amount  which  as  a  carrier  it  would  other- 
wise charge,  such  carrier  shall  pay  a  tax  equivalent  to 
the  tax  which  would  be  imposed  upon  the  transportation 
of  such  commodity  if  the  carrier  received  payment  for 
such  transportation:  Provided,  That  in  case  of  a  car- 
rier which  on  May  first,  nineteen  hundred  and  seven- 
teen, had  no  rates  or  tariffs  on  file  with  the  proper  Fed- 
eral or  State  authority,  the  tax  shall  be  computed  on 
the  basis  of  the  rates  or  tariffs  of  other  carriers  for  like 
services  as  ascertained  and  determined  by  the  Commis- 
sioner of  Internal  Revenue:  Provided  further,  That 
nothing  in  this  or  the  preceding  section  shall  be  con- 
strued as  imposing  a  tax  (a)  upon  the  transportation  of 
any  commodity  which  is  necessary  for  the  use  of  the 
carrier  in  the  conduct  of  its  business  as  such  and  is 
intended  to  be  so  used  or  has  been  so  used;  or  (b)  upon 
the  transportation  of  company  material  transported  by 
one  carrier,  which  constitutes  a  part  of  a  railroad  sys- 
tem, for  another  carrier  which  is  also  a  part  of  the  same 
system. 

United  States  and  States  exempt  from  tax. — Sec.  502. 
That  no  tax  shall  be  imposed  under  section  five  hundred 


WAR   TAX   ON    UTILITIES  593 

upon  any  payment  received  for  services  rendered  to 
the  United  States,  or  any  State,  Territory,  or  the  Dis- 
trict of  Columbia.  The  right  to  exemption  under  this 
section  shall  be  evidenced  in  such  manner  as  the  Com- 
missioner of  Internal  Revenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  may  by  regulation  prescribe. 

Tax  returns  and  payment. — Sec.  503.  That  each  person, 
corporation,  partnership,  or  association  receiving  any 
payments  referred  to  in  section  five  hundred  shall  collect 
the  amount  of  the  tax,  if  any,  imposed  by  such  section 
from  the  person,  corporation,  partnership,  or  associa- 
tion making  such  payments,  and  shall  make  monthly  re- 
turns under  oath,  in  duplicate,  and  pay  the  taxes  so  col- 
lected and  the  taxes  imposed  upon  it  under  paragraph 
two  of  section  five  hundred  and  one  to  the  collector  of 
internal  revenue  of  the  district  in  which  the  principal 
office  or  place  of  business  is  located.  Such  returns  shall 
contain  such  information,  and  be  made  in  such  manner, 
as  the  Commissioner  of  Internal  Eevenue,  with  the  ap- 
proval of  the  Secretary  of  the  Treasury,  may  by  regu- 
lation prescribe. 

War  tax  on  insurance  policies. — Sec.  504.  That  from 
and  after  the  first  day  of  November,  nineteen  hundred 
and  seventeen,  there  shall  be  levied,  assessed,  collected, 
and  paid  the  following  taxes  on  the  issuance  of  insur- 
ance policies:  (a)  Life  insurance:  A  tax  equivalent  to 
8  cents  on  each  $100  or  fractional  part  thereof  of  the 
amount  for  which  any  life  is  insured  under  any  policy 
of  insurance,  or  other  instrument,  by  whatever  name  the 
same  is  called :  Provided,  That  on  all  policies  for  life 
insurance  only  by  which  a  life  is  insured  not  in  excess 
of  $500,  issued  on  the  industrial  or  weekly  payment 
plan  of  insurance,  the  tax  shall  be  forty  per  centum  of 
the  amount  of  the  first  weekly  premium:  Provided 
further,  That  policies  of  reinsurance  shall  be  exempt 
from  the  tax  imposed  by  this  subdivision;  (b)  Marine, 
inland,  and  fire  insurance:    A  tax  equivalent  to  1  cent 


594  INCOME   AND    FEDERAL    TAX   REPORTS 

on  each  dollar  or  fractional  part  thereof  of  the  pre- 
mium charged  under  each  policy  of  insurance  or  other  in- 
strument by  whatever  name  the  same  is  called  whereby 
insurance  is  made  or  renewed  upon  property  of  any  de- 
scription (including  rents  or  profits),  whether  against 
peril  by  sea  or  inland  waters,  or  by  fire  or  lightning, 
or  other  peril:  Provided,  That  policies  of  reinsurance 
shall  be  exempt  from  the  tax  imposed  by  this  subdi- 
vision ; 

(c)  Casualty  insurance:  A  tax  equivalent  to  1  cent 
on  each  dollar  or  fractional  part  thereof  of  the  premium 
charged  under  each  policy  of  insurance  or  obligation  of 
the  nature  of  indemnity  for  loss,  damage,  or  liability 
(except  bonds  taxable  under  subdivision  two  of  Sched- 
ule A  of  Title  VIII)  issued  or  executed  or  renewed 
by  any  person,  corporation,  partnership,  or  associa- 
tion, transacting  the  business  of  employer's  liability, 
workmen's  compensation,  accident,  health,  tornado,  plate 
glass,  steam  boiler,  elevator,  burglary,  automatic  sprink- 
ler, automobile,  or  other  branch  of  insurance  (except  life 
insurance,  and  insurance  described  and  taxed  in  the  pre- 
ceding subdivision) :  Provided,  That  policies  of  rein- 
surance shall  be  exempt  from  the  tax  imposed  by  this 
subdivision ; 

(d)  Policies  issued  by  any  person,  corporation,  part- 
nership, or  association,  whose  income  is  exempt  from 
Taxation  under  Title  I  of  the  Act  entitled  "An  Act  to 
increase  the  revenue,  and  for  other  purposes,"  approved 
September  eighth,  nineteen  hundred  and  sixteen,  shall 
be  exempt  from  the  taxes  imposed  by  this  section. 

Insurance  tax  returns  and  payment. — Sec.  505.  That 
every  person,  corporation,  partnership,  or  association, 
issuing  policies  of  insurance  upon  the  issuance  of  which 
a  tax  is  imposed  by  section  five  hundred  and  four,  shall, 
within  the  first  fifteen  days  of  each  month,  make  a  re- 
turn under  oath,  in  duplicate,  and  pay  such  tax  to  the 
collector  of  internal  revenue  of  the  district  in  which 


WAR   TAX   ON    UTILITIES  595 

the  principal  office  or  place  of  business  of  such  person, 
corporation,  partnership,  or  association  is  located.  Such 
returns  shall  contain  such  information  and  be  made  in 
such  manner  as  the  Commissioner  of  Internal  Eevenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  may 
by  regulation  prescribe. 

Approved  by  the  President,  October  3,  1917. 


CHAPTER  XXIX 

WAR  TAX   ON  ADMISSIONS  AND 

DUES 

What  is  taxed. — The  war  tax  on  admissions l  and 
dues,  effective  on  and  after  November  1,  1917,  is  a  tax 
of  1  cent  for  each  10  cents  or  fraction  thereof,  and  in 
some  cases  of  10  per  cent,  of  charges  made  for  admis- 
sion to  any  place  to  which  an  admission  charge  is  made 
for  private  or  personal  profit.  Among  the  classes  of 
admissions  so  taxable  are  those  to  theaters,  cabarets, 
club  memberships  and  athletic  and  racing  associations. 
The  tax  payable  in  each  case  is  specified  below  under 
the  appropriate  heading. 

The  tax  being  upon  the  privilege  of  admission,  lia- 
bility to  tax  upon  any  admission  or  dues  depends,  as 
has  recently  been  decided  by  the  Treasury  Department, 
not  upon  the  date  of  the  payment,  but  upon  the  date  of 
the  admission  or  the  period  for  which  the  dues  are  paid. 
Earlier  rulings,  no  longer  in  effect,  had  imposed  the  tax, 
for  example,  also  upon  amounts  paid  for  dues  in  ar- 
rears, if  such  amounts  were  actually  received  after  the 
tax  became  effective. 

The  object  of  the  tax,  like  that  of  the  war  excise  tax, 
seems  to  be  to  collect  a  revenue  from  the  nation's  ex- 
penditures for  what  may  be  called  "near-luxuries."  It 
is  at  the  other  extreme  in  principle  from  the  ancient 
expedient,  not  yet  wholly  abandoned  in  some  parts  of 
the  world,  of  taxing  absolute  necessities,  such  as  salt. 
It  will  be  seen  that  few,  if  any,  of  the  admissions  and 

i  The  term  "admission"  includes  seats  and  tables,  reserved  or  otherwise, 
and  other  similar  accommodations,  and  the  charges  made  therefor. 

596 


WAR    TAX   ON   ADMISSIONS   AND   DUES  597 

dues  taxable  are  other  than  those  that  represent  the 
price  the  public  is  willing  to  pay  for  amnsements  or 
social  exclusiveness,  neither  of  which  are  absolutely 
necessary  for  the  maintaining  of  life,  however  helpful 
they  may  be  in  maintaining  the  life  to  which  the  pub- 
lic has  become  accustomed. 

Exemptions. — General  exemptions  from  the  tax  are  as 
follows : 

(1)  Admission  to  a  place  the  maximum  charge  for 
admission  to  which  is  5  cents,  or  to  shows,  rides  and 
other  amusements  (the  maximum  charge  for  admission 
to  which  is  10  cents)  within  outdoor  general  amusement 
parks,  or  to  such  outdoor  general  amusement  parks. 

(2)  Admissions,  all  the  proceeds x  of  which  inure 
exclusively  to  the  benefit  of  religious,  educational,  or 
charitable  institutions,  societies,  or  organizations 2  or 
admissions  to  agricultural  fairs  none  of  the  profits  of 
which  are  distributed  to  stockholders  or  members  of  the 
association  conducting  the  same. 

(3)  Amounts  paid  as  dues  or  fees  to  a  fraternal 
beneficiary  society,  order,  or  association  operating  un- 
der the  lodge  system  or  for  the  exclusive  benefit  of  the 
members  of  a  fraternity  itself  operating  under  the  lodge 
system,  and  providing  for  the  payment  of  life,  sick, 
accident,  or  other  benefits  to  the  members  of  such  so- 
ciety, order  or  association,  or  their  dependents. 

Specific  cases  concerning  exemptions  passed  on  by 
the  Treasury  Department  include  the  following: 

Dues  charged  by  the  Y.  M.  C.  A.  and  the  Y.  M.  H.  A. 
are  exempt. 

Complimentary  tickets  issued  to  benefit  concerts  or 
entertainments  for  a  charity  hospital  or  for  other 
similar  institutions,  the  proceeds  of  which  are  exempt 

iThe  word  "proceeds"  is  held  to  mean  gross  receipts  less  payments  of 
proper  expenses;  or,  in  other  words,  "net  proceeds." 

2  To  be  a  religious,  educational,  or  charitable  institution,  society  or  or- 
ganization, such  purposes  must  be  its  primary  or  principal  function. 


600  INCOME    AND    FEDERAL    TAX    REPORTS 

tax  is  computed  on  the  basis  of  the  price  paid  for  simi- 
lar boxes  at  single  performances  by  parties  who  pay 
for  each  performance  severally.  The  tax  may  be  com- 
puted, if  there  are  no  other  boxes  of  similar  size,  by 
taking  as  a  basis  the  price  charged  for  a  single  seat  in 
smaller  or  larger  boxes,  or  if  there  are  no  other  boxes, 
the  price  of  a  single  seat  in  the  same  part  of  the  house, 
and  multiplying  this  price  by  the  number  of  seats  in 
the  box  in  question. 

In  the  case  of  admission  by  season  ticket  or  subscrip- 
tion, the  amount  of  the  tax  is  equivalent  to  1  cent  for 
each  10  cents  of  the  proportion  of  the  amount  paid  for 
such  season  or  subscription  covering  admissions  on  or 
after  November  1,  1917. 

On  and  after  December  15th  no  person  may  be  ad- 
mitted to  any  place  to  which  admission  is  charged 
unless  the  ticket,  card  or  pass  by  which  he  is  admitted 
bears  evidence  that  the  tax  due  in  respect  of  the  admis- 
sion covered  by  it  has  been  paid.  This  evidence  must 
consist  of  the  printing  or  stamping  upon  the  ticket, 
card,  pass  or  other  papers  evidencing  the  right  to  ad- 
mission the  words  "tax  paid."  Each  proprietor  of  any 
place  to  which  admission  is  charged  not  specifically 
exempted  from  taxation  by  the  Act  must  provide  him- 
self with  such  a  stamp  as  may  be  necessary  for  this 
purpose.  Such  stamp  must  be  applied  to  the  ticket, 
card,  pass,  or  other  evidence  of  the  right  to  admission, 
at  the  place  where  it  is  issued.  All  tickets,  passes, 
cards  or  other  evidence  of  the  right  to  admission  issued 
before  November  1,  but  used  after  November  1,  must 
be  "validated"  before  they  are  used  by  collecting  the 
tax  and  stamping  them  in  accordance  with  the  above 
requirements. 

Where  there  is  no  box  office  price,  the  amount  so  paid 
for  admission  is  taxable. 

Traveling  theatrical  companies  paying  special  taxes 
as  theaters,  not  showing  in  regular  buildings  built  and 


WAR    TAX    ON   ADMISSIONS   AND   DUES 


601 


rented  for  that  purpose,  should  collect  the  tax  on  ad- 
missions. If  they  show  in  regular  theaters  or  opera 
houses  the  owners  of  such  houses  should  collect  and 
file  the  returns.  Where  the  proprietor  of  a  theater 
leases  his  premises  and  reserves  a  box  for  his  own  use, 
the  tax  collected  on  this  box  is  the  same  as  that  col- 
lected on  any  other  box  or  like  accommodation  at  the 
same  theater.  One  who  rents  or  leases  a  theater  out- 
right for  one  or  more  performances  must  make  return 
and  pay  the  tax,  but  the  proprietor  of  the  theater  is 
required  to  show  in  his  returns  the  dates  when  and  the 
parties  to  whom  he  rents  or  leases  the  place. 

Where  theaters  are  not  permitted  to  charge  admis- 
sion but  overcome  the  difficulty  by  taking  a  "silver  col- 
lection" at  the  door  there  is  no  objection  to  selling 
revenue  tickets  with  each  contribution,  a  ten-cent  con- 
tributor paying  11  cents. 

The  following  is  an  illustration  of  the  computation 
of  the  tax  on  admissions  applicable  to  theaters  and 
other  places  where  the  rate  of  tax  is  1  cent  for  each  10 
cents  or  fraction: 

Admission    35  cents     tax  4  cents     total  to  be  collected  39  cents 

Reserved  Seats   25  cents 

Reserved  Seats    15  cents 

Admission    25  cents 

Admission    10  cents 

Admission    (child)     ....      5  cents 

There  is  no  stamp  tax  on  such  tickets:  the  seller  of 
the  ticket  collects  the  tax  computed  on  each  ticket  sepa- 
rately. Daily  cash  register  receipts  cannot  be  taken  as 
a  basis  for  computing  the  amount  of  tax  due,  unless  all 
admissions  are  10  cents  or  multiples  of  10  cents. 

The  aggregate  amount  of  tax  is  to  be  entered  in  the 
return,  computed  as  above  directed,  upon  each  admis- 
sion and  each  free  admission  separately.  In  comput- 
ing the  tax  upon  each  payment,  a  fraction  of  a  cent  is 
to  be  disregarded  unless  it  amounts  to  one  half  cent  or 
more,  in  which  case  it  is  to  be  counted  as  one  cent. 


"    3  cents 

tt          a 

28  cents 

"    2  cents 

"          " 

17  cents 

"    3  cents 

H            M 

28  cents 

"    1  cent 

H          u 

'           11  cents 

"    1  cent 

a          ti 

'             6  cents 

602  INCOME   AND    FEDERAL    TAX   REPORTS 

Airdomes.  —  Airdomes  do  not  come  within  the  ex- 
emption of  open-air  parks,  and  admissions  thereto  are 
taxable. 

Dance  halls. — Admissions  to  dance  halls  are  taxable, 
but  charges  for  the  privilege  of  dancing,  in  addition  to 
the  charges  for  admission,  are  not  taxable.  If  a  group 
of  people  get  together  and  take  up  a  collection  or  con- 
tribution of  money  to  pay  for  the  music,  such  collec- 
tion or  contribution  would  not  be  regarded  as  price  paid 
for  admission  to  a  dance. 

Sums  paid  for  private  dancing  or  class  lessons  are 
not  subject  to  tax. 

Cabarets. — In  the  case  of  cabarets  or  other  similar  en- 
tertainments to  which  the  charge  for  admission  is  wholly 
or  in  part  included  in  the  price  paid  for  refreshment, 
service,  or  merchandise,  the  amount  paid  for  admission 
is  estimated  by  the  Treasury  Department  as  being  one- 
fifth  of  the  patron's  total  bill.  The  tax,  accordingly,  is 
1  cent  for  each  10  cents  or  fraction  thereof  of  an  amount 
equal  to  20  per  cent  of  the  bill,  unless  satisfactory  evi- 
dence is  presented  to  the  Collector  that  a  different  per- 
centage should  be  fixed.  For  example :  if  the  bill  amounts 
to  $5,  the  tax  is  10  cents.  A  fraction  of  a  cent  is  to  be 
disregarded  unless  it  amounts  to  one  half  cent  or  more, 
in  which  case  it  is  increased  to  1  cent.  Tips  are  not  to 
be  included  in  the  amount  which  forms  the  basis  of  the 
tax.  Cabarets  include  any  place  in  which  any  enter- 
tainment is  conducted  in  connection  with  the  sale  of 
food,  refreshments,  etc.,  except  that  the  tax  does  not  ap- 
ply to  hotels,  restaurants,  etc.,  where  only  instrumental 
music  is  furnished,  but  does  apply  if  there  is  dancing 
by  the  patrons. 

Eeturns,  in  the  case  of  cabarets,  must  be  made  on  or 
before  the  10th  day  of  each  month.     (T.  D.  2603.) 

Miscellaneous  admissions. — Taxable  admissions  include 
those  to  Sunday  afternoon  orchestral  concerts,  admis- 
sions to  caves  and  similar  exhibitions,  and  admissions 
to  food  shows. 


WAR    TAX   ON   ADMISSIONS   AND   DUES  603 

Athletic  and  racing  associations. — Admissions  to  college 
athletic  exhibitions,  as  well  as  to  any  other  similar  ex- 
hibitions, such  as  track  meets,  football  and  baseball 
games,  are  taxable,  unless  all  the  net  proceeds  are  given 
to  the  college  itself,  or  to  some  other  institution  exempt 
from  taxation  under  the  Act. 

The  tax  attaches  upon  subscriptions  to  racing  asso- 
ciations regardless  of  whether  or  not  the  subscriber  at- 
tends any  of  the  meets.  The  association  itself  may  pay 
the  tax  due  for  any  person  admitted  free. 

The  provision  of  the  section  which  allows  bona-fide 
employees  to  be  admitted  tax-free  applies  only  to  actual 
employees  of  the  association  and  not  to  employees  of 
the  owners  of  racing  horses. 

Fairs. — Agricultural  fair  associations  must  collect  and 
pay  the  tax  if  any  of  the  proceeds  are  distributed  to 
members  or  stockholders  of  the  association.  If  no  such 
profits  are  to  be  so  distributed  the  tax  does  not  attach 
to  admission  charges. 

Club  dues. — Dues  or  fees  admitting  to  membership  in 
social  clubs  are  taxable  at  the  rate  of  10  per  cent,  if 
such  dues  exceed  $12  a  year. 

Any  organization  which  maintains  headquarters  for 
the  purpose  of  affording  its  members  the  opportunity 
of  informally  congregating  for  social  intercourse  is  a 
social  club  within  the  meaning  of  the  law,  and  the  dues 
therefore  are  taxable.  Business  men's  oganizations,  such 
as  Chambers  of  Commerce,  are  not  taxable,  however,  by 
reason  of  the  fact  that  social  features  may  be  included 
in  their  meetings  with  the  object  of  maintaining  their 
membership  for  business  purposes. 

Tax  must  be  paid  upon  all  dues  representing  mem- 
bership privileges  for  any  time  elapsing  after  October 
31,  1917,  regardless  of  the  time  of  payment.  Thus,  in 
a  case  of  dues  exceeding  $12  a  year  paid  for  the  calen- 
dar year  1917,  a  tax  will  be  due  on  one-sixth  of  the  full 
amount  paid  for  such  calendar  year,  irrespective  of 
the  date  of  payment 


604        INCOME   AND    FEDERAL    TAX    REPORTS 

Where  a  club  charges  an  initiation  fee  in  addition  to 
annual  dues  the  taxability  of  the  club  is  estimated  upon 
the  annual  dues  plus  the  initiation  fee. 

Assessment  dues;  life  membership  fees;  college  fra- 
ternity dues;  and  "green  fees"  paid  by  a  member  of  a 
golf  club  for  a  guest  are  all  taxable. 

Where  the  annual  dues  exceed  $12,  but  are  paid  in 
two  or  more  annual  installments,  the  payments  are  tax- 
able when  made,  pro  rata. 

The  tax  does  not  attach  in  a  case  where  the  only 
initiation  fee  charged  is  the  purchase  of  a  share  of  stock 
in  the  club. 

Where  membership  entitles  a  member  to  admission 
with  one  guest,  no  further  tax  is  required  for  admis- 
sion of  such  guest.  Other  guests  admitted  free  of 
charge,  however,  must  pay  the  tax. 

The  tax  on  club  dues  may  be  paid  by  the  clubs  them- 
selves. 

Y.  M.  C.  A.  and  Y.  M.  H.  A.  dues  and  admissions  are 
not  taxable. 

Returns. — Every  person,  corporation,  partnership  or 
association  receiving  payment  for  admissions,  or  admit- 
ting any  person  free,  is  obligated  to  collect  the  tax  due 
in  each  case  and  to  make  returns  as  provided  in  section 
503  of  the  Act. 

Eeturns  must  be  made  in  duplicate  on  or  before  the 
last  day  of  each  month  covering  the  preceding  month 
(in  the  case  of  cabarets  on  the  10th  of  each  month), 
and  the  tax  required  to  be  collected  must  be  paid  over 
to  the  collector  of  the  district  in  which  is  situated  the 
principal  office  or  place  of  business.  This  return  is  made 
on  Form  729. 

There  must  be  kept  in  each  box  or  ticket  office  of  every 
theater,  place  of  amusement,  or  other  place  to  which 
admissions  subject  to  the  tax  are  charged  a  daily  rec- 
ord of  the  number  and  kind  of  tickets  sold  and  the  tax 
collected  thereon.    Such  record  must  also  show  the  num- 


WAR    TAX   ON   ADMISSIONS   AND   DUES  605 

ber  of  passes  used  for  admission  each  day  and  the  tax 
collected  thereon  and  the  number  of  admissions  of  chil- 
dren under  twelve  years  of  age  and  the  tax  collected 
thereon.  Each  separate  class  of  tickets  sold  must  be  so 
distinctly  indicated  as  to  be  capable  of  ready  verifica- 
tion by  the  Internal  Eevenue  Department.  A  separate 
record  must  be  kept  of  the  number  and  kind  of  tickets, 
cards,  passes  or  other  evidence  of  right  to  admission  on 
or  after  November  1,  1917,  paid  for  or  issued  prior  to 
November  1  and  of  the  tax  collected  in  respect  thereof. 
The  monthly  return  required  to  be  filed  by  proprietors 
of  all  places  to  which  admission  is  charged,  not  expressly 
exempt  from  taxation,  must  include  and  cover  amounts 
collected  on  validation  of  tickets,  passes,  cards,  or  other 
evidence  of  the  right  to  admission. 

In  computing  the  tax,  a  fraction  of  a  cent  is  to  be  dis- 
regarded unless  it  amounts  to  one  half  cent  or  more,  in 
which  case  it  is  to  be  counted  as  one  cent.  Such  frac- 
tions, however,  are  likely  to  be  encountered  only  in  cases 
where  the  tax  is  a  straight  percentage  of  the  charge  for 
admission.  Where  the  tax  is  1  cent  for  each  10  cents 
or  fraction  thereof  of  the  price  of  admission,  no  frac- 
tions of  cents  will  be  encountered. 

Penalties. — The  penalties  are:  for  failure  to  submit  a 
return  within  the  time  prescribed,  a  fine  of  not  more 
than  $1,000  or  imprisonment  for  not  more  than  one  year, 
or  both;  and  for  failure  to  collect  or  truly  to  account 
for  and  pay  over  the  tax,  an  additional  penalty  of  double 
the  tax  not  collected  or  accounted  for. 

A  recent  decision  of  the  Treasury  Department  in  the 
case  of  the  stamp  tax  on  railroad  tickets  construes  the 
penalty  for  non-payment  as  being  also  upon  the  pur- 
chaser of  the  ticket ;  it  seems  possible  that  a  similar  con- 
struction of  the  law  might  be  made  to  apply  in  the  case 
of  the  tax  on  admissions  and  dues. 


604  INCOME   AND    FEDERAL    TAX    REPORTS 

Where  a  club  charges  an  initiation  fee  in  addition  to 
annual  dues  the  taxability  of  the  club  is  estimated  upon 
the  annual  dues  plus  the  initiation  fee. 

Assessment  dues;  life  membership  fees;  college  fra- 
ternity dues;  and  "green  fees"  paid  by  a  member  of  a 
golf  club  for  a  guest  are  all  taxable. 

Where  the  annual  dues  exceed  $12,  but  are  paid  in 
two  or  more  annual  installments,  the  payments  are  tax- 
able when  made,  pro  rata. 

The  tax  does  not  attach  in  a  case  where  the  only 
initiation  fee  charged  is  the  purchase  of  a  share  of  stock 
in  the  club. 

Where  membership  entitles  a  member  to  admission 
with  one  guest,  no  further  tax  is  required  for  admis- 
sion of  such  guest.  Other  guests  admitted  free  of 
charge,  however,  must  pay  the  tax. 

The  tax  on  club  dues  may  be  paid  by  the  clubs  them- 
selves. 

Y.  M.  C.  A.  and  Y.  M.  H.  A.  dues  and  admissions  are 
not  taxable. 

Returns. — Every  person,  corporation,  partnership  or 
association  receiving  payment  for  admissions,  or  admit- 
ting any  person  free,  is  obligated  to  collect  the  tax  due 
in  each  case  and  to  make  returns  as  provided  in  section 
503  of  the  Act. 

Returns  must  be  made  in  duplicate  on  or  before  the 
last  day  of  each  month  covering  the  preceding  month 
(in  the  case  of  cabarets  on  the  10th  of  each  month), 
and  the  tax  required  to  be  collected  must  be  paid  over 
to  the  collector  of  the  district  in  which  is  situated  the 
principal  office  or  place  of  business.  This  return  is  made 
on  Form  729. 

There  must  be  kept  in  each  box  or  ticket  office  of  every 
theater,  place  of  amusement,  or  other  place  to  which 
admissions  subject  to  the  tax  are  charged  a  daily  rec- 
ord of  the  number  and  kind  of  tickets  sold  and  the  tax 
collected  thereon.    Such  record  must  also  show  the  num- 


WAR    TAX   ON   ADMISSIONS   AND   DUES  605 

ber  of  passes  used  for  admission  each  day  and  the  tax 
collected  thereon  and  the  number  of  admissions  of  chil- 
dren under  twelve  years  of  age  and  the  tax  collected 
thereon.  Each  separate  class  of  tickets  sold  must  be  so 
distinctly  indicated  as  to  be  capable  of  ready  verifica- 
tion by  the  Internal  Kevenue  Department.  A  separate 
record  must  be  kept  of  the  number  and  kind  of  tickets, 
cards,  passes  or  other  evidence  of  right  to  admission  on 
or  after  November  1,  1917,  paid  for  or  issued  prior  to 
November  1  and  of  the  tax  collected  in  respect  thereof. 
The  monthly  return  required  to  be  filed  by  proprietors 
of  all  pJaces  to  which  admission  is  charged,  not  expressly 
exempt  from  taxation,  must  include  and  cover  amounts 
collected  on  validation  of  tickets,  passes,  cards,  or  other 
evidence  of  the  right  to  admission. 

In  computing  the  tax,  a  fraction  of  a  cent  is  to  be  dis- 
regarded unless  it  amounts  to  one  half  cent  or  more,  in 
which  case  it  is  to  be  counted  as  one  cent.  Such  frac- 
tions, however,  are  likely  to  be  encountered  only  in  cases 
where  the  tax  is  a  straight  percentage  of  the  charge  for 
admission.  Where  the  tax  is  1  cent  for  each  10  cents 
or  fraction  thereof  of  the  price  of  admission,  no  frac- 
tions of  cents  will  be  encountered. 

Penalties. — The  penalties  are:  for  failure  to  submit  a 
return  within  the  time  prescribed,  a  fine  of  not  more 
than  $1,000  or  imprisonment  for  not  more  than  one  year, 
or  both;  and  for  failure  to  collect  or  truly  to  account 
for  and  pay  over  the  tax,  an  additional  penalty  of  double 
the  tax  not  collected  or  accounted  for. 

A  recent  decision  of  the  Treasury  Department  in  the 
case  of  the  stamp  tax  on  railroad  tickets  construes  the 
penalty  for  non-payment  as  being  also  upon  the  pur- 
chaser of  the  ticket ;  it  seems  possible  that  a  similar  con- 
struction of  the  law  might  be  made  to  apply  in  the  case 
of  the  tax  on  admissions  and  dues. 


-J 


CHAPTER  XXX 

WAR  TAX  ON  ADMISSIONS  AND 
DUES  LAW 

BEING  TITLE  VII  OF  "AN  ACT  TO  PROVIDE  REVENUE 

TO  DEFRAY  WAR  EXPENSES,  AND  FOR  OTHER 

PURPOSES,"  APPROVED  OCTOBER  3,   1917. 

(PUBLIC— No.  50— 65th  CONGRESS).    IN 

EFFECT  OCTOBER  4,  1917,  UNLESS 

OTHERWISE  SPECIALLY 

PROVIDED. 


TITLE   VII.— WAR   TAX   ON  ADMISSIONS   AND   DUES, 
EFFECTIVE  NOV.  1,  1917. 

Amount  of  tax  on  admissions. — Sec.  700  [of  the  general 
revenue  Act  of  which  this  Title  is  a  part].  That  from 
and  after  the  first  day  of  November,  nineteen  hundred 
and  seventeen,  there  shall  be  levied,  assessed,  collected, 
and  paid,  (a)  a,  tax  of  1  cent  for  each  10  cents  or  frac- 
tion thereof  of  the  amount  paid  for  admission  to  any 
place,  including  admission  by  season  ticket  or  subscrip- 
tion, to  be  paid  by  the  person  paying  for  such  admis- 
sion: Provided,  That  the  tax  on  admission  of  children 
under  twelve  years  of  age  where  an  admission  charge  for 
such  children  is  made  shall  in  every  case  be  1  cent;  and 

Tax  on  free  admissions  and  passes,  except  in  certain  cases. 
— {b)  In  the  case  of  persons  (except  bona  fide  em- 
ployees, municipal  officers  on  official  business,  and  chil- 
dren under  twelve  years  of  age)  admitted  free  to  any 
place  at  a  time  when  and  under  circumstances  under 
which  an  admission  charge  is  made  to  other  persons  of 
the  same  class,  a  tax  of  1  cent  for  each  10  cents  or 

606 


/ 

WAR    TAX    ON    ADMISSION  607 

fraction  thereof  of  the  price  so  charged  to  such  other 
persons  for  the  same  or  similar  accommodations,  to  be 
paid  by  the  persons  so  admitted;  and 

Tax  on  cabarets. — (c)  A  tax  of  1  cent  for  each  10 
cents  or  fraction  thereof  paid  for  admission  to  any  public 
performance  for  profit  at  any  cabaret  or  other  similar 
entertainment  to  which  the  charge  for  admission  is  wholly 
or  in  part  included  in  the  price  paid  for  refreshment, 
service,  or  merchandise;  the  amount  paid  for  such  ad- 
mission to  be  computed  under  rules  prescribed  by  the 
Commissioner  of  Internal  Eevenue,  with  the  approval 
of  the  Secretary  of  the  Treasury,  such  tax  to  be  paid 
by  the  person  paying  for  such  refreshments,  service,  or 
merchandise. 

Tax  on  reserved  boxes  or  seats. — In  the  case  of  persons 
having  the  permanent  use  of  boxes  or  seats  in  an  opera 
house  or  any  place  of  amusement  or  a  lease  for  the  use 
of  such  box  or  seat  in  such  opera  house  or  place  of 
amusement  there  shall  be  levied,  assessed,  collected,  and 
paid  a  tax  equivalent  to  ten  per  centum  of  the  amount 
for  which  a  similar  box  or  seat  is  sold  for  performance 
or  exhibition  at  which  the  box  or  seat  is  used  or  reserved 
by  or  for  the  lessee  or  holder. 

When  5  and  10-eent  admissions  are  exempt. — These  taxes 
shall  not  be  imposed  in  the  case  of  a  place  the  maxi- 
mum charge  for  admission  to  which  is  5  cents,  or  in  the 
case  of  shows,  rides,  and  other  amusements,  (the  maxi- 
mum charge  for  admission  to  which  is  ten  cents)  within 
outdoor  general  amusement  parks,  or  in  the  case  of  ad- 
missions to  such  parks. 

Other  exemptions. — No  tax  shall  be  levied  under  this 
title  in  respect  to  any  admissions  all  the  proceeds  of 
which  inure  exclusively  to  the  benefit  of  religious,  ed- 
ucational, or  charitable  institutions,  societies,  or  organi- 
zations, or  admissions  to  agricultural  fairs,  none  of  the 
profits  of  which  are  distributed  to  stockholders  or  mem- 
bers of  the  association  conducting  the  same. 


608  INCOME   AND    FEDERAL    TAX   REPORTS 

Definition  of  admission. — The  term  "admission"  as  used 
in  this  title  includes  seats  and  tables,  reserved  or  other- 
wise, and  other  similar  accommodations,  and  the  charges 
made  therefor. 

Tax  on  dues  and  membership  fees. — Sec.  701.  That  from 
and  after  the  first  day  of  November,  nineteen  hundred 
and  seventeen,  there  shall  be  levied,  assessed,  collected, 
and  paid,  a  tax  equivalent  to  ten  per  centum  of  any 
amount  paid  as  dues  or  membership  fees  (including  in- 
itiation fees),  to  any  social,  athletic,  or  sporting  club  or 
organization,  where  such  dues  or  fees  are  in  excess  of 
$12  per  year ;  such  taxes  to  be  paid  by  the  person  pay- 
ing such  dues  or  fees : 

Specific  exemptions. — Provided,  That  there  shall  be 
exempted  from  the  provisions  of  this  section  all  amounts 
paid  as  dues  or  fees  to  a  fraternal  beneficiary  society, 
order,  or  association,  operating  under  the  lodge  system 
or  for  the  exclusive  benefit  of  the  members  of  a  fratern- 
ity itself  operating  under  the  lodge  system,  and  provid- 
ing for  the  payment  of  life,  sick,  accident,  or  other 
benefits  to  the  members  of  such  society,  order,  or  asso- 
ciation or  their  dependents. 

Method  of  payment  of  taxes. — Sec.  702.  That  every 
person,  corporation,  partnership,  or  association  (a)  re- 
ceiving any  payments  for  such  admission,  dues,  or  fees, 
shall  collect  the  amount  of  the  tax  imposed  by  section 
seven  hundred  or  seven  hundred  and  one  from  the  per- 
son making  such  payments,  or  (b)  admitting  any  person 
free  to  any  place  for  admission  to  which  a  charge  is 
made  shall  collect  the  amount  of  the  tax  imposed  by  sec- 
tion seven  hundred  from  the  person  so  admitted,  and 
(c)  in  either  case  shall  make  returns  and  payments  of 
the  amounts  so  collected,  at  the  same  time  and  in  the 
same  manner  as  provided  in  section  five  hundred  and 
three  of  this  Act. 

Approved  by  the  President,  October  3,  1917. 


CHAPTER  XXXI 
COLLECTION  DISTRICTS 

AND  NAMES  AND  ADDRESSES  OF  COLLECTORS. 


( The  name  of  the  collection  district  is  the  same,  unless  otherwise 
indicated,  as  the  name  of  the  State  in  which  the  collector 
has  his  residence.) 

ALABAMA  (Includes  Mississippi),  John  D.  McNeel, 
Birmingham. 

ALASKA  (See  Washington). 

ARIZONA  (See  New  Mexico). 

ARKANSAS,  Jack  Walker,  Little  Rock. 

CALIFORNIA: 

First  District. — The  counties  of  Alameda,  Alpine, 
Amador,  Butte,  Calaveras,  Colusa,  Contra  Costa,  Del 
Norte,  Eldorado,  Fresno,  Glenn,  Humboldt,  Inyo, 
Kings,  Lake,  Lassen,  Madera,  Marin,  Mariposa, 
Mendocino,  Merced,  Modoc,  Mono,  Monterey,  Napa, 
Nevada,  Placer,  Plumas,  Sacramento,  San  Benito, 
San  Francisco,  San  Joaquin,  San  Mateo,  Santa 
Clara,  Santa  Cruz,  Shasta,  Sierra,  Siskiyou,  Solano, 
Sonoma,  Stanislaus,  Sutter,  Tulare,  Tehama,  Trin- 
ity, Tuolumne,  Yolo,  Yuba,  and  the  State  of  Ne- 
vada, Justus  S.  Wardell,  San  Francisco. 

Sixth  District. — The  counties  of  Imperial,  Kern, 
Los  Angeles,  Orange,  Riverside,  San  Bernardino, 
San  Diego,  San  Luis  Obispo,  Santa  Barbara,  and 
Ventura,  John  P.  Carter,  Los  Angeles. 

COLORADO  (Including  Wyoming),  Mark  A.  Skinner, 
Denver. 

609 


610  INCOME   AND    FEDERAL    TAX   REPORTS 

CONNECTICUT   (Includes  Khode  Island),  James  J. 
Walsh,  Hartford. 

DELAWARE  (See  Maryland). 

DISTRICT  OF  COLUMBIA  (See  Maryland). 

FLORIDA,  James  M.  Cathcart,  Jacksonville. 

GEORGIA,  Aaron  0.  Blalock,  Atlanta. 

HAWAII,  John  F.  Haley,  Honolulu. 

IDAHO  (See  Montana). 

ILLINOIS: 

First  District. — The  counties  of  Boone,  Carroll, 
Cook,  DeKalb,  Dupage,  Grundy,  Jo  Daviess,  Kane, 
Kankakee,  Kendall,  Lake,  Lasalle,  Lee,  McHenry, 
Ogle,  Stephenson,  Whiteside,  Will,  and  Winnebago, 
Julius  F.  Smietanka,  Chicago. 

Fifth  District. — The  counties  of  Bureau,  Hender- 
son, Henry,  Knox,  Marshall,  Mercer,  Peoria,  Put- 
nam, Eock  Island,  Stark,  and  Warren,  Edward  D. 
McCabe,  Peoria. 

Eighth  District. — The  counties  of  Adams,  Bond, 
Brown,  Calhoun,  Cass,  Champaign,  Christian,  Coles, 
Cumberland,  Dewitt,  Douglas,  Edgar,  Ford,  Fulton, 
Greene,  Hancock,  Iroquois,  Jersey,  Livingston, 
Logan,  McDonough,  McLean,  Macon,  Macoupin, 
Mason,  Menard,  Montgomery,  Morgan,  Moultrie, 
Piatt,  Pike,  Sangamon,  Schuyler,  Scott,  Shelby, 
Tazewell,  Vermilion,  and  Woodford,  John  L.  Pick- 
ering, Springfield. 

Thirteenth  District. — The  counties  of  Alexander, 
Clark,  Clay,  Clinton,  Crawford,  Edwards,  Effing- 
ham, Fayette,  Franklin,  Gallatin,  Hamilton,  Hardin, 
Jackson,  Jasper,  Jefferson,  Johnson,  Lawrence, 
Madison,  Marion,  Massac,  Monroe,  Perry,  Pope, 
Pulaski,  Randolph,  Richland,  St.  Clair,  Saline, 
Union,  Wabash,  Washington,  Wayne,  White,  and 
Williamson,  John  M.  Rapp,  East  St.  Louis. 


COLLECTION    DISTRICTS  611 

INDIANA: 

Sixth  District.— The  counties  of  Adams,  Allen, 
Bartholomew,  Benton,  Blackford,  Brown,  Cass, 
Dearborn,  Decatur,  Dekalb,  Delaware,  Elkhart,  Fay- 
ette, Franklin,  Fulton,  Grant,  Hamilton,  Hancock, 
Hendricks,  Henry,  Howard,  Huntington,  Jackson, 
Jasper,  Jay,  Jefferson,  Jennings,  Johnson,  Kos- 
ciusko, Lagrange,  Lake,  Laporte,  Lawrence,  Madi- 
son, Marion,  Marshall,  Miami,  Monroe,  Morgan, 
Newton,  Noble,  Ohio,  Porter,  Pulaski,  Eandolph, 
Eipley,  Rush,  St.  Joseph,  Shelby,  Starke,  Steuben, 
Switzerland,  Tipton,  Union,  Wabash,  Wayne,  Wells, 
White,  and  Whitley.  Peter  J.  Kruyer,  Indianapolis. 

Seventh  District. — The  counties  of  Boone,  Car- 
roll, Clark,  Clay,  Clinton,  Crawford,  Daviess,  Du- 
bois, Floyd,  Fountain,  Gibson,  Greene,  Harrison, 
Knox,  Martin,  Montgomery,  Orange,  Owen,  Parke, 
Perry,  Pike,  Posey,  Putnam,  Scott,  Spencer,  Sul- 
livan, Tippecanoe,  Vanderburg,  Vermilion,  Vigo, 
Warren,  Warrick,  and  Washington.  Isaac  R. 
Strouse,  Terre  Haute. 

IOWA,  Louis  Murphy,  Dubuque. 

KANSAS,  Wm.  H.  L.  Pepperell,  Wichita. 

KENTUCKY: 

Second  District. — The  counties  of  Allen,  Ballard, 
Barren,  Breckenridge,  Butler,  Caldwell,  Calloway, 
Carlisle,  Christian,  Clinton,  Crittenden,  Cumber- 
land, Daviess,  Edmonson,  Fulton,  Graves,  Gray- 
son, Hancock,  Hart,  Henderson,  Hickman,  Hopkins, 
Livingston,  Logan,  Lyon,  McCracken,  McLean, 
Marshall,  Metcalfe,  Monroe,  Muhlenberg,  Ohio,  Rus- 
sell, Simpson,  Todd,  Trigg,  Union,  Warren,  and 
Webster,  Josh  T.  Griffith,  Owensboro. 

Fifth  District. — The  city  of  Louisville  and  the 
counties  of  Adair,  Bullitt,  Casey,  Green,  Hardin, 
Henry,  Jefferson,  Larue,   Marion,   Meade,  Nelson, 


612  INCOME   AND    FEDERAL    TAX   REPORTS 

Oldham,  Owen,  Shelby,  Spencer,  Taylor,  and  Wash- 
ton,  Thomas  S.  Mayes,  Louisville. 

Sixth  District. — The  counties  of  Boone,  Bracken, 
Campbell,  Carroll,  Gallatin,  Grant,  Harrison,  Ken- 
ton, Pendleton,  Eobertson,  and  Trimble,  Charlton 
B.  Thompson,  Covington. 

Seventh  District. — The  counties  of  Bath,  Bour- 
bon, Boyd,  Carter,  Clark,  Elliott,  Fayette,  Fleming, 
Franklin,  Greenup,  Johnson,  Lawrence,  Lewis, 
Martin,  Mason,  Menifee,  Montgomery,  Morgan, 
Nicholas,  Powell,  Eowan,  Scott,  and  Woodford,  Ben 
Marshall,  Lexington. 

Eighth  District. — The  counties  of  Anderson,  Bell, 
Boyle,  Breathitt,  Clay,  Estill,  Floyd,  Garrard,  Har- 
lan, Jackson,  Jessamine,  Knott,  Knox,  Laurel,  Lee, 
Leslie,  Letcher,  Lincoln,  Madison,  Magoffin,  Mercer, 
McCreary,  Owsley,  Perry,  Pike,  Pulaski,  Rock- 
castle, Wayne,  Whitley,  and  Wolfe,  John  W. 
Hughes,  Danville. 

LOUISIANA,  John  Y.  Fauntleroy,  New  Orleans. 

MAINE  (See  New  Hampshire). 

MARYLAND,  Joshua  W.  Miles,  Baltimore. 

District  of  Maryland  consists  of  the  following- 
named  territory :  The  State  of  Maryland  and  Dela- 
ware, the  District  of  Columbia,  and  the  counties  of 
Accomac  and  Northampton  of  the  State  of  Virginia. 

MASSACHUSETTS,  John  F.  Malley,  Boston. 

This  district  is  officially  designated  as  the  Third 
District  of  Massachusetts. 

MICHIGAN, 

First  District. — Counties  of  Alcona,  Alpena,  Are- 
nac, Bay,  Branch,  Calhoun,  Cheboygan,  Clare,  Clin- 
ton, Crawford,  Genessee,  Gladwin,  Gratiot,  Hills- 
dale, Huron,  Ingham,  Iosco,  Isabella,  Jackson,  La- 
peer, Lenawee,  Livingston,  Macomb,  Midland,  Mon- 
roe, Montmorency,  Oakland,  Ogemaw,  Oscoda,  Ot- 


COLLECTION    DISTRICTS  613 

sego,  Presque  Isle,  Eoscommon,  Saginaw,  Sanilac, 
Shiawassee,  St.  Clair,  Tuscola,  Washtenaw,  and 
Wayne,  James  J.  Brady,  Detroit. 

Fourth  District. — Counties  of  Alger,  Allegan,  An- 
trim, Baraga,  Barry,  Benzie,  Berrien,  Cass,  Charle- 
voix, Chippewa,  Delta,  Dickinson,  Eaton,  Emmet, 
Gogebic,  Grand  Traverse,  Houghton,  Ionia,  Iron, 
Kalamazoo,  Kaikaska,  Kent,  Keweenaw,  Lake,  Lee- 
lanau, Luce,  Mackinac,  Manistee,  Marquette,  Mason, 
Mecosta,  Menominee,  Missaukee,  Montcalm,  Muske- 
gon, Newaygo,  Oceana,  Ontonagon,  Osceola,  Ottawa, 
St.  Joseph,  Schoolcraft,  Van  Buren,  and  Wexford, 
Emanuel  L.  Doyle,  Grand  Rapids. 

MINNESOTA,  Edward  J.  Lynch,  St.  Paul. 

MISSISSIPPI  (See  Alabama). 

The  State  of  Mississippi  detached  from  the  Dis- 
trict of  Louisiana  and  added  to  the  District  of  Ala- 
bama June  1,  1908. 

MISSOURI, 

First  District. — The  counties  of  Adair,  Audrain, 
Bollinger,  Boone,  Butler,  Callaway,  Cape  Girardeau, 
Carter,  Clark,  Crawford,  Dent,  Dunklin,  Franklin, 
Gasconade,  Howard,  Iron,  Jefferson,  Knox,  Lewis, 
Lincoln,  Linn,  Macon,  Madison,  Maries,  Marion, 
Mississippi,  Montgomery,  Monroe,  New  Madrid, 
Oregon,  Osage,  Pemiscot,  Perry,  Phelps,  Pike,  Pu- 
laski, Ralls,  Randolph,  Reynolds,  Ripley,  St. 
Charles,  St.  Francois,  Ste.  Genevieve,  St.  Louis, 
Schuyler,  Scotland,  Scott,  Shannon,  Shelby,  Stod- 
dard, Warren,  Washington,  and  Wayne,  George  H. 
Moore,  St.  Louis. 

Sixth  District. — The  counties  of  Andrew,  Atchi- 
son, Barry,  Barton,  Bates,  Benton,  Buchanan,  Cald- 
well, Camden,  Carroll,  Cass,  Cedar,  Chariton, 
Christian,  Clay,  Clinton,  Cole,  Cooper,  Dade,  Dallas, 
Daviess,  Dekalb,  Douglas,  Gentry,  Greene,  Grundy, 


614  INCOME   AND    FEDERAL    TAX   REPORTS 

Harrison,  Henry,  Hickory,  Holt,  Howell,  Jackson, 
Jasper,  Johnson,  Laclede,  Lafayette,  Lawrence,  Liv- 
ingston, McDonald,  Mercer,  Miller,  Moniteau,  Mor- 
gan, Newton,  Nodaway,  Ozark,  Pettis,  Platte,  Polk, 
Putnam,  Ray,  St.  Clair,  Saline,  Stone,  Sullivan, 
Taney,  Texas,  Vernon,  Webster,  Worth,  and 
Wright,  Edgar  M.  Harber,  Kansas  City. 

MONTANA    (Includes  Utah  and   Idaho),    William  C. 
Whaley,  Helena. 

NEBRASKA,  Geo.  L.  Loomis,  Omaha. 

NEVADA  (See  First  California). 

NEW  HAMPSHIRE   (Includes  Maine  and  Vermont), 
Seth  W.  Jones,  Portsmouth. 

NEW  JERSEY: 

First  District. — The  counties  of  Atlantic,  Burling- 
ton, Camden,  Cape  May,  Cumberland,  Gloucester, 
Mercer,  Monmouth,  Ocean,  and  Salem,  Samuel  Ire- 
dell, Camden. 

Fifth  District. — The  counties  of  Bergen,  Essex, 
Hudson,  Hunterdon,  Middlesex,  Morris,  Passaic, 
Somerset,  Sussez,  Union,  and  Warren,  Charles  V. 
Duffy,  Newark. 

NEW  MEXICO  (Includes  Arizona),  Lewis  T.  Carpenter, 
Phoenix,  Arizona. 

NEW  YORK: 

First  District. — The  counties  of  Kings,  Nassau, 
Queens,  Richmond,  and  Suffolk,  Henry  P.  Keith, 
Brooklyn. 

Second  District. — The  old  first,  second,  third, 
fourth,  fifth,  sixth,  eighth,  ninth,  and  fifteenth 
wards  of  New  York  City;  that  portion  of  the  old 
fourteenth  ward  lying  west  of  the  centre  of  Mott 
Street ;  that  portion  of  the  old  sixteenth  ward  lying 
south  of  the  centre  of  West  Twenty-fourth  Street, 
and  Governors  Island,  William  H.  Edwards,  Cus- 
tom House,  New  York. 


COLLECTION   DISTRICTS  615 

Third  District. — The  old  seventh,  tenth,  eleventh, 
twelfth,  thirteenth,  seventeenth,  eighteenth,  nine- 
teenth, twentieth,  twenty-first,  and  twenty-second 
wards  of  New  York  City ;  that  part  of  the  old  four- 
teenth ward  lying  east  of  the  centre  of  Mott  Street ; 
that  part  of  the  old  sixteenth  ward  lying  north  of 
the  center  of  West  Twenty-fourth  Street,  and  Black- 
wells,  Randalls,  and  Wards  Islands,  Mark  Eisner, 
1150  Broadway  (27th  Street),  New  York. 

Fourteenth  District. — The  counties  of  Albany, 
Clinton,  Columbia,  Dutchess,  Essex,  Fulton,  Greene, 
Hamilton,  Montgomery,  Orange,  Putnam,  Rens- 
selaer, Rockland,  Saratoga,  Schenectady,  Schoharie, 
Sullivan,  Ulster,  Warren,  Washington,  and  West- 
chester, and  the  old  twenty-third  and  twenty-fourth 
wards  of  New  York  City,  Roscoe  Irwin,  Albany 

Twenty-first  District. — The  counties  of  Broome, 
Cayuga,  Chenango,  Cortland,  Delaware,  Franklin, 
Herkimer,  Jefferson,  Lewis,  Madison,  Oneida,  Onon- 
daga, Oswego,  Otsego,  St.  Lawrence,  Schuyler,  Sen- 
eca, Tioga,  Tompkins,  and  Wayne,  Neil  Brewster, 
Syracuse. 

Twenty-eighth  District. — The  counties  of  Alle- 
gany, Cattaraugus,  Chautauqua,  Chemung,  Erie, 
Genes  see,  Livingston,  Monroe,  Niagara,  Ontario, 
Orleans,  Steuben,  Wyoming,  and  Yates,  Vincent  H. 
Riordan,  Buffalo. 
NORTH  CAROLINA: 

Fourth  District.  —  The  counties  of  Alamance, 
Beaufort,  Bertie,  Bladen,  Brunswick,  Camden,  Car- 
teret, Caswell,  Chatham,  Chowan,  Columbus,  Cra- 
ven, Cumberland,  Currituck,  Dare,  Duplin,  Durham, 
Edgecombe,  Franklin,  Gates,  Granville,  Greene, 
Halifax,  Harnett,  Hertford,  Hyde,  Johnston,  Jones, 
Lenoir,  Martin,  Montgomery,  Moore,  Nash,  New 
Hanover,  Northampton,  Onslow,  Orange,  Pamlico, 
Pasquotank,    Pender,    Perquimans,    Person,    Pitt, 


616  INCOME    AND    FEDERAL    TAX    REPORTS 

Richmond,  Robeson,  Sampson,  Scotland,  Tyrrell, 
Vance,  Wake,  Warren,  Washington,  Wayne,  and 
Wilson,  Josiah  W.  Bailey,  Raleigh. 

Fifth  District. — The  counties  of  Alexander,  Alle- 
gany, Anson,  Ashe,  Buncombe,  Burke,  Cabarrus, 
Caldwell,  Catawba,  Cherokee,  Clay,  Cleveland,  David- 
son, Davie,  Forsyth,  Gaston,  Graham,  Guilford, 
Haywood,  Henderson,  Iredell,  Jackson,  Lincoln,  Mc- 
Dowell, Macon,  Madison,  Mecklenburg,  Mitchell, 
Polk,  Randolph,  Rockingham,  Rowan,  Rutherford, 
Stanly,  Stokes,  Surry,  Swain,  Transylvania,  Union, 
Watauga,  Wilkes,  Yadkin,  and  Yancey,  Alston  D. 
Watts,  Statesville. 

NORTH  AND  SOUTH  DAKOTA,  James  Coffey,  Aber- 
deen, S.  Dakota. 

OHIO: 

First  District. — The  counties  of  Brown,  Butler, 
Clarke,  Clermont,  Clinton,  Fayette,  Greene,  Hamil- 
ton, Highland,  Miami,  Montgomery,  Preble,  and 
Warren,  Andrew  C.  Gilligan,  Cincinnati. 

Tenth  District. — The  counties  of  Allen,  Auglaize, 
Champaign,  Crawford,  Darke,  Defiance,  Erie,  Ful- 
ton, Hancock,  Hardin,  Henry,  Huron,  Logan,  Lucas, 
Mercer,  Ottawa,  Paulding,  Putnam,  Sandusky, 
Seneca,  Shelby,  Van  Wert,  Williams,  Wood,  and 
Wyandot,  Frank  B.  Niles,  Toledo. 

Eleventh  District.  —  The  counties  of  Adams, 
Athens,  Coshocton,  Delaware,  Fairfield,  Franklin, 
Gallia,  Guernsey,  Hocking,  Jackson,  Knox,  Law- 
rence, Licking,  Madison,  Marion,  Meigs,  Morgan, 
Morrow,  Muskingum,  Noble,  Perry,  Pickaway,  Pike, 
Ross,  Scioto,  Union,  Vinton,  and  Washington, 
Beriah  E.  Williamson,  Columbus. 

Eighteenth  District. — The  counties  of  Ashland, 
Ashtabula,  Belmont,  Carroll,  Columbiana,  Cuya- 
hoga, Geauga,  Harrison,  Holmes,  Jefferson,  Lake, 


COLLECTION    DISTRICTS  617 

Lorain,  Mahoning,  Medina,  Monroe,  Portage,  Rich- 
land,  Stark,   Summit,   Trumbull,   Tuscarawas,   and 
Wayne,  Harry  H.  Weiss,  Cleveland. 
OKLAHOMA,  Hubert  L.  Bolen,  Oklahoma  City. 
OREGON,  Milton  A.  Miller,  Portland. 
PENNSYLVANIA: 

First  District. — The  counties  of  Berks,  Bucks, 
Chester,  Delaware,  Lehigh,  Montgomery,  Philadel- 
phia, and  Schuylkill,  Ephraim  Lederer,  Philadelphia. 

Ninth  District. — The  counties  of  Adams,  Bedford, 
Blair,  Cumberland,  Dauphin,  Franklin,  Fulton, 
Huntingdon,  Juniata;  Lancaster,  Lebanon,  Mifflin, 
Perry,  Snyder,  York,  Benjamin  F.  Davis,  Lancaster. 

Twelfth  District.  —  Bradford,  Carbon,  Center, 
Clinton,  Columbia,  Lackawanna,  Luzerne,  Lycom- 
ing, Monroe,  Montour,  Northampton,  Northumber- 
land, Pike,  Potter,  Sullivan,  Susquehanna,  Tioga, 
Union,  Wayne,  Wyoming.  (Twelfth  District  re- 
established May  1,  1915.)  Fred  C.  Kirkendall, 
Scranton. 

Twenty-third  District. — The  counties  of  Alle- 
gheny, Armstrong,  Beaver,  Butler,  Cambria,  Cam- 
eron, Clarion,  Clearfield,  Crawford,  Elk,  Erie,  Fay- 
ette, Forest,  Greene,  Indiana,  Jefferson,  Lawrence, 
McKean,  Mercer,  Somerset,  Venango,  Warren, 
Washington,  and  Westmoreland,  C.  Gregg  Lewellyn, 
Pittsburgh. 

PHILIPPINE  ISLANDS,  James  J.  Rafferty,  Manila. 
RHODE  ISLAND  (See  Connecticut). 
SOUTH  CAROLINA,  Duncan  C.  Hey  ward,  Columbia. 
SOUTH  DAKOTA   (See  North  and  South  Dakota). 
TENNESSEE,  Edward  B.  Craig,  Nashville. 
TEXAS,  Alexander  S.  Walker,  Austin 
UTAH  (See  Montana). 
VERMONT   (See  New  Hampshire). 


618  INCOME   AND   FEDERAL    TAX   REPORTS 

VIRGINIA: 

Second  District. — The  counties  of  Amelia,  Ap- 
pomattox, Brunswick,  Buckingham,  Caroline, 
Charles  City,  Chesterfield,  Cumberland,  Dinwiddie, 
Elizabeth  City,  Essex,  Fluvanna,  Gloucester,  Gooch- 
land, Greensville,  Hanover,  Henrico,  Isle  of  Wight, 
James  City,  King  and  Queen,  King  George,  King 
William,  Lancaster,  Louisa,  Lunenburg,  Mathews, 
Middlesex,  Nansemond,  New  Kent,  Norfolk,  North- 
umberland, Nottaway,  Powhatan,  Prince  Edward, 
Prince  George,  Princess  Anne,  Kichmond,  Stafford, 
Southampton,  Spottsylvania,  Surry,  Sussex,  War- 
wick, Westmoreland,  and  York,  Richard  C.  L.  Mon- 
cure,  Eichmond. 

Sixth  District. — The  counties  of  Albemarle,  Alex- 
andria, Alleghany,  Amherst,  Augusta,  Bath,  Bed- 
ford, Bland,  Botetourt,  Buchanan,  Campbell,  Car- 
roll, Charlotte,  Clarke,  Craig,  Culpeper,  Dickenson, 
Fairfax,  Fauquier,  Floyd,  Franklin,  Frederick, 
Giles,  Grayson,  Greene,  Halifax,  Henry,  Highland, 
Lee,  Loudoun,  Madison,  Mecklenburg,  Montgomery, 
Nelson,  Orange,  Page,  Patrick,  Pittsylvania,  Prince 
William,  Pulaski,  Eappahannock,  Eoanoke,  Eock- 
bridge,  Eockingham,  Eussell,  Scott,  Shenandoah, 
Smyth,  Tazewell,  Warren,  Washington,  Wise,  and 
Wythe,  John  M.  Hart,  Eoanoke. 
The  counties  of  Accomac  and  Northampton  are  in  the 

District  of  Maryland. 

WASHINGTON  (Includes  Alaska),  David  J.  Williams, 
Tacoma. 

WEST  VIRGINIA,  Samuel  A.  Hays,  Parkersburg. 

WISCONSIN: 

First  District.  —  Counties  of  Brown,  Calumet, 
Dodge,  Door,  Florence,  Fond  du  Lac,  Forest,  Green 
Lake,  Kenosha,  Kewaunee,  Monitowoc,  Marinette, 
Marquette,   Milwaukee,   Oconto,   Outogamie,   Ozau- 


COLLECTION    DISTRICTS  619 

kee,  Eacine,  Shawano,  Sheboygan,  Walworth,  Wash- 
ington, Waukesha,  Waupaca,  Waushara,  Winne- 
bago, and  county  of  Langlade  with  exception  of  the 
eight  townships  of  said  county  which  were  formerly 
in  Lincoln  County,  Paul  A.  Hemmy,  Milwaukee. 

Second  District. — Counties  of  Adams,  Ashland, 
Barron,  Bayfield,  Buffalo,  Burnett,  Chippewa, 
Clark,  Columbia,  Crawford,  Dane,  Douglas,  Dunn, 
Eau  Clair,  Grant,  Green,  Iowa,  Iron,  Jackson,  Jef- 
ferson, Juneau,  La  Crosse,  Lafayette,  Lincoln, 
Marathon,  Monroe,  Oneida,  Pepin,  Pierce,  Polk, 
Portage,  Price,  Eichland,  Eock,  Eusk,  St.  Croix, 
Sauk,  Sawyer,  Taylor,  Trempealeau,  Vernon,  Vilas, 
Washburn,  Wood,  and  the  eight  townships  in  the 
western  part  of  Langlade  County  which  were  for- 
merly in  Lincoln  County,  Burt  Williams,  Madison. 
WYOMING  (See  Colorado). 

A  list  of  the  several 
INTERNAL    REVENUE   DIVISIONS 

with  the 
Names  and  Addresses  of  Agents  in  Charge 


Corrected  to  July  25,  1917 


ALABAMA See  Nashville  Division. 

ALASKA See  Portland  Division. 

AEIZONA See  Denver  Division. 

AEKANSAS See  Little  Eock  Division. 

CALIFOENIA See  San  Francisco  Division. 

COLOEADO See  Denver  Division. 

CONNECTICUT See  New  Haven  Division. 

DELAWAEE See  Baltimore  Division. 

DIST.  OF  COLUMBIA.  See  Baltimore  Division. 

FLOEIDA See  Atlanta  Division. 

GEOEGIA See  Atlanta  Division. 


620  INCOME   AND    FEDERAL    TAX   REPORTS 

HAWAII See  San  Francisco  Division. 

IDAHO See  Salt  Lake  Division. 

ILLINOIS See  Chicago  and  Springfield  Di- 
visions. 

INDIANA See  Indianapolis  Division. 

IOWA See  Omaha  Division. 

KANSAS See  Little  Rock  Division. 

KENTUCKY See  Huntington  and  Louisville 

Divisions. 

LOUISIANA See  New  Orleans  Division. 

MAINE See  Boston  Division. 

MARYLAND See  Baltimore  Division. 

MASSACHUSETTS  ...  See  Boston  Division. 

MICHIGAN   See  Detroit  Division. 

MINNESOTA See  St.  Paul  Division. 

MISSISSIPPI  See  New  Orleans  Division. 

MISSOURI See  St.  Louis  Division. 

MONTANA See  Salt  Lake  Division. 

NEBRASKA See  Omaha  Division. 

NEVADA See  San  Francisco  Division. 

NEW  HAMPSHIRE. . .  See  Boston  Division. 

NEW  JERSEY See  Elizabeth  Division. 

NEW  MEXICO See  Denver  Division. 

NEW  YORK See  Buffalo,    New   Haven   and 

New  York  Divisions. 

NORTH  CAROLINA.. .  See  Greensboro  Division. 

NORTH  DAKOTA See  St.  Paul  Division. 

OHIO See  Cincinnati  and  Cleveland  Di- 
visions. 

OKLAHOMA See  Little  Rock  Division. 

OREGON See  Portland  Division. 

PENNSYLVANIA See  Philadelphia  and  Pittsburgh 

Divisions. 

RHODE  ISLAND See  New  Haven  Division. 

SOUTH  CAROLINA. . .  See  Greensboro  Division. 

SOUTH  DAKOTA See  St.  Paul  Division. 

TENNESSEE See  Nashville  Division. 


COLLECTION    DISTRICTS  621 

TEXAS See  San  Antonio  Division. 

UTAH See  Salt  Lake  Division. 

VEBMONT See  Boston  Division. 

VIRGINIA See  Bichmond  Division. 

WASHINGTON See  Portland  Division. 

WEST  VIRGINIA See  Huntington  Division. 

WISCONSIN See  Milwaukee  Division. 

WYOMING See  Denver  Division. 

Atlanta  Division,  E.  C.  Yellowley,  Atlanta,  Ga. 
Georgia  and  Florida. 

Baltimore  Division,  E.  A.  Forbes,  Baltimore,  Md. 
Maryland,  Delaware  and  District  of  Columbia. 

Boston  Division,  R.  C.  Shelley,  Boston,  Mass. 

Maine,  New  Hampshire,  Vermont  and   Massachu- 
setts. 

Buffalo  Division,  S.  D.  Amen,  Buffalo,  N.  Y. 
21st  and  28th  Districts  of  New  York. 

Chicago  Division,  Dan  J.  Chapin,  Chicago,  111. 
1st  and  5th  Districts  of  Illinois. 

Cincinnati  Division,  T.  E.  Stone,  Cincinnati,  Ohio. 

1st  and  11th  Districts  of  Ohio. 
Cleveland  Division,  W.  H.  Collier,  Cleveland,  Ohio. 

10th  and  18th  Districts  of  Ohio. 

Denver  Division,  Harvey  H.  Sltjsser,  Denver,  Col. 
Colorado,  Wyoming,  New  Mexico  and  Arizona. 

Detroit  Division,  Lee  A.  Miller,  Detroit,  Mich. 
1st  and  4th  Districts  of  Michigan. 

Elizabeth  Division,  D.  K.  Donaldson,  Elizabeth,  N.  J. 

1st  and  5th  Districts  of  New  Jersey. 
Greensboro  Division,  T.  H.  Vanderpord,  Greensboro,  N.  C. 

North  and  South  Carolina. 

Huntington  Division,  James  O'Brien,  Huntington,  W.  Va. 
West  Virginia  and  the  7th  District  of  Kentucky. 


622  INCOME    AND    FEDERAL    TAX    REPORTS 

Indianapolis  Division,  Geo.  W.  Trowbridge,  Indianapolis, 
Ind. 

6th  and  7th  Districts  of  Indiana. 
Little  Rock  Division,  Jas.  S.  Barkman,  Little  Eock,  Ark. 

Arkansas,  Oklahoma  and  Kansas. 
Louisville  Division,  Wm.  D.  Chandler,  Louisville,  Ky. 

2nd,  5th,  6th,  and  8th  Districts  of  Kentucky. 
Milwaukee  Division,  James  W.  McGinnis,  Milwaukee,  Wis. 

1st  and  2nd  Districts  of  Wisconsin. 
Nashville  Division,  Daniel  L.  Porter,  Nashville,  Term. 

Tennessee  and  Alabama. 
New  Haven  Division,  Theo.  M.  Byxbee,  New  Haven,  Conn. 

Ehode  Island,  Connecticut,  and  14th  District  of  New 
York,  except  Westchester  County,  and  the  23rd 
and  24th  Wards  of  New  York  City,  being  a  part 
of  the  14th  District  of  New  York. 
New  Orleans  Division,  J.  0.  Bender,  New  Orleans,  La. 

Louisiana  and  Mississippi. 
New  York  Division,  L.  G.  Nutt,  New  York,  N.  Y. 

1st,  2d  and  3d  Districts  of  New  York,  and  Westches- 
ter County,  and  the  23rd  and  24th  Wards  of 
New  York  City,  being  a  part  of  the  14th  District 
of  New  York. 
Omaha  Division,  John  A.  McCabe,  Omaha,  Neb. 

Iowa  and  Nebraska. 
Philadelphia  Division,  John  W.  Sinsel,  Philadelphia,  Pa. 

1st  and  12th  Districts  of  Pennsylvania. 
Pittsburgh  Division,  Frank  L.  Boyd,  Pittsburgh,  Pa. 

9th  and  23rd  Districts  of  Pennsylvania. 
Portland  Division,  Allen  Carnes,  Portland,  Ore. 

Oregon,  Washington  and  Alaska. 
Richmond  Division,  S.  E.  Brame,  Eichmond,  Va. 

2nd  and  6th  Districts  of  Virginia. 
Salt  Lake  Division,  W.  H.  Chapman,  Salt  Lake,  Utah. 

Utah,  Montana  and  Idaho. 


COLLECTION    DISTRICTS  623 

San  Antonio  Division,  Jas.  J.  Drakeford,  San  Antonio, 

Texas. 
San  Francisco  Division,  C.  E.  Boulden,  San  Francisco,  Cal. 

California,  Hawaii  and  Nevada. 
Springfield  Division,  W.  P.  Smith,  Springfield,  111. 

8th  and  13th  Districts  of  Illinois. 
St.  Louis  Division,  John  M.  Eodgers,  St.  Louis,  Mo. 

1st  and  6th  Districts  of  Missouri. 
St.  Paul  Division,  W.  W.  Anderson,  St.  Paul,  Minn. 

Minnesota  and  North  and  South  Dakota. 

Collection  Districts  for  New  York  City. 

New  York  City  (Greater  New  York)  is  embraced 
within  four  collection  districts;  the  First,  the  Second, 
the  Third  and  the  Fourteenth  New  York. 

First  District.  The  Boroughs  of  Brooklyn,  Queens 
and  Eichmond  are  in  the  First  District;  Office,  Post 
Office,  Brooklyn. 

Second  District.  The  Borough  of  Manhattan  (Man- 
hattan Island)  itself  consists  of  two  collection  districts, 
the  Second  and  the  Third.  The  Second  District  (Office 
— Custom  House)  consists  of  that  portion  of  Manhattan 
Borough  which  is  bounded  by  the  East  Eiver  from  the 
center  of  Catharine  Slip  (Pier  26,  E.  E.,  four  blocks 
north  of  Brooklyn  Bridge)  to  the  Battery;  by  the  North 
Eiver  from  the  Battery  to  the  center  of  West  24th 
Street  (Pier  64,  N.  E.) ;  and  by  a  line,  beginning  at  the 
North  (Hudson)  Eiver,  running  east  along  the  center  of 
West  Twenty-fourth  Street  to  the  center  of  Sixth  Ave- 
nue, down  the  center  of  Sixth  Avenue  to  the  center  of 
Fourteenth  Street,  east  along  the  center  of  Fourteenth 
Street  to  the  center  of  Fourth  Avenue,  down  the  center 
of  Fourth  Avenue  to  Cooper  Square,  around  the  north 
and  east  sides  of  Cooper  Square  (i.  e.,  all  of  Cooper 
Square  is  in  the  Second  District)  to  the  east  side  of  the 
Bowery,  down  the  east  side  of  the  Bowery  to  the  center  of 


624  INCOME   AND    FEDERAL    TAX   REPORTS 

East  Houston  Street  (i.  e.,  both  sides  of  the  Bowery  north 
of  East  Houston  Street  are  in  the  Second  District),  west 
along  the  center  of  East  Houston  Street  to  the  center  of 
Mott  Street,  down  the  center  of  Mott  Street  to  the  center 
of  Canal  Street,  east  along  the  center  of  Canal  Street  to 
the  center  of  the  Bowery,  down  the  center  of  the  Bowery 
to  the  center  of  Catharine  Street  (at  Division  Street), 
along  the  center  of  Catharine  Street  to  Catharine  Slip 
and  across  the  center  of  Catharine  Slip  to  the  East 
Eiver  (Pier  26,  E.  E.).  The  Second  District  includes 
Governors  Island  also. 

Third  District  The  Third  District  (Office,  1150 
Broadway,  between  26th  and  27th  Streets)  embraces  all 
of  the  rest  of  Manhattan  Island;  that  is,  all  of  Manhat- 
tan Borough  not  included  within  the  boundaries  of  the 
Second  District  outlined  above,  together  with  Black- 
well's,  Bandall's  and  Ward's  Islands. 

Fourteenth  District.  The  rest  of  Greater  New  York, 
that  is,  all  of  Bronx  Borough,  which  lies  north  and  east 
of  the  Harlem  Ship  Canal  and  the  Harlem  Eiver,  is  in  the 
Fourteenth  District  (Office,  Albany). 


CHAPTER  XXXII 
WAR  EXCESS  PROFITS  TAX  LAW 

BEING  TITLE  II  OF  "AN  ACT  TO  PROVIDE  REVENUE  TO 

DEFRAY  WAR  EXPENSES,  AND  FOR  OTHER 

PURPOSES,"  APPROVED  OCTOBER  3,  1917 

(PUBLIC— No.  50— 65th  CONGRESS)  IN 

EFFECT  OCTOBER  4,  1917,  UNLESS 

OTHERWISE  SPECIALLY 

PROVIDED 


TITLE   II.— WAR   EXCESS   PROFITS   TAX,   EFFECTIVE 
OCTOBER  4,  1917. 

Definitions. — Sec.  200  [of  the  general  revenue  Act  of 
which  this  Title  is  a  part].  That  when  used  in  this 
title — 

The  term  "corporation"  includes  joint-stock  com- 
panies or  associations,  and  insurance  companies; 

The  term  "domestic"  means  created  under  the  law  of 
the  United  States,  or  of  any  State,  Territory,  or  District 
thereof,  and  the  term  "foreign"  means  created  under 
the  law  of  any  other  possession  of  the  United  States  or 
of  any  foreign  country  or  government; 

The  term  "United  States"  means  only  the  States,  the 
Territories  of  Alaska  and  Hawaii,  and  the  District  of 
Columbia ; 

"Taxable  year." — The  term  "taxable  year"  means  the 
twelve  months  ending  December  thirty-first,  excepting 
in  the  case  of  a  corporation  or  partnership  which  has 
fixed  its  own  fiscal  year,  in  which  case  it  means  such 

625 


626  INCOME    AND    FEDERAL    TAX    REPORTS 

fiscal  year.  The  first  taxable  year  shall  be  the  year 
ending  December  thirty-first,  nineteen  hundred  and  sev- 
enteen, except  that  in  the  case  of  a  corporation  or  part- 
nership which  has  fixed  its  own  fiscal  year,  it  shall  be 
the  fiscal  year  ending  during  the  calendar  year  nineteen 
hundred  and  seventeen.  If  a  corporation  or  partner- 
ship, prior  to  March  first,  nineteen  hundred  and  eight- 
teen,  makes  a  return  covering  its  own  fiscal  year,  and 
includes  therein  the  income  received  during  that  part 
of  the  fiscal  year  falling  within  the  calendar  year  nine- 
teen hundred  and  sixteen,  the  tax  for  such  taxable  year 
shall  be  that  proportion  of  the  tax  computed  upon  the 
net  income  during  such  full  fiscal  year  which  the  time 
from  January  first,  nineteen  hundred  and  seventeen,  to 
the  end  of  such  fiscal  year  bears  to  the  full  fiscal  year; 
and 

"Pre-war  period." — The  term  "pre-war  period"  means 
the  calendar  years  nineteen  hundred  and  eleven,  nine- 
teen hundred  and  twelve,  and  nineteen  hundred  and 
thirteen,  or,  if  a  corporation  or  partnership  was  not  in 
existence  or  an  individual  was  not  engaged  in  a  trade 
or  business  during  the  whole  of  such  period,  then  as 
many  of  such  years  during  the  whole  of  which  the  cor- 
poration or  partnership  was  in  existence,  or  the  indi- 
vidual was  engaged  in  the  trade  or  business. 

"Trade"  and  "business." — The  terms  "trade"  and  "busi- 
ness" include  professions  and  occupations. 

"Net  income"  in  case  of  foreign  corporations  and  others. — 
The  term  "net  income"  means  in  the  case  of  a  foreign 
corporation  or  partnership  or  a  non-resident  alien  in- 
dividual, the  net  income  received  from  sources  within 
the  United  States. 

Rates  of  Tax. — Sec.  201.  That  in  addition  to  the  taxes 
under  existing  law  and  under  this  Act  there  shall  be 
levied,  assessed,  collected,  and  paid  for  each  taxable 
year  upon  the  income  of  every  corporation,  partnership, 
or  individual,  a  tax  (hereinafter  in  this  title  referred 


WAR    EXCESS    PROFITS    TAX   LAW  627 

to  as  the  tax)  equal  to  the  following  percentages  of  the 
net  income: 

Twenty  per  centum  of  the  amount  of  the  net  income 
in  excess  of  the  deduction  (determined  as  hereinafter 
provided)  and  not  in  excess  of  fifteen  per  centum  of 
the  invested  capital  for  the  taxable  year; 

Twenty-five  per  centum  of  the  amount  of  the  net  in- 
come in  excess  of  fifteen  per  centum  and  not  in  excess 
of  twenty  per  centum  of  such  capital; 

Thirty-five  per  centum  of  the  amount  of  the  net  in- 
come in  excess  of  twenty  per  centum  and  not  in  excess 
of  twenty-five  per  centum  of  such  capital; 

Forty-five  per  centum  of  the  amount  of  the  net  in- 
come in  excess  of  twenty-five  per  centum  and  not  in 
excess  of  thirty-three  per  centum  of  such  capital;  and 

Sixty  per  centum  of  the  amount  of  the  net  income  in 
excess  of  thirty-three  per  centum  of  such  capital. 

All  income  of  corporation  or  partnership  deemed  received 
from  its  business. — For  the  purpose  of  this  title  every 
corporation  or  partnership  not  exempt  under  the  pro- 
visions of  this  section  shall  be  deemed  to  be  engaged 
in  business,  and  all  the  trades  and  businesses  in  which 
it  is  engaged  shall  be  treated  as  a  single  trade  or  busi- 
ness, and  all  its  income  from  whatever  source  derived 
shall  be  deemed  to  be  received  from  such  trade  or 
business. 

Certain  incomes  not  subject  to  this  tax. — This  title  shall 
apply  to  all  trades  or  businesses  of  whatever  descrip- 
tion, whether  continuously  carried  on  or  not,  except — 

(a)  In  the  case  of  officers  and  employees  under  the 
United  States,  or  any  State,  Territory,  or  the  District 
of  Columbia,  or  any  local  subdivision  thereof,  the  com- 
pensation or  fees  received  by  them  as  such  officers  or 
employees ; 

(b)  Corporations  exempt  from  tax  under  the  pro- 
visions of  section  eleven  of  Title  I  of  such  Act  of  Sep- 
tember eighth,  nineteen  hundred  and  sixteen,  as  amended 


628  INCOME    AND    FEDERAL    TAX    REPORTS 

by  this  Act,  and  partnerships  and  individuals  carrying 
on  or  doing  the  same  business,  or  coming  within  the  same 
description   [for  exempt  corporations  see  p.  315],  and 

(c)  Incomes  derived  from  the  business  of  life,  health, 
and  accident  insurance  combined  in  one  policy  issued  on 
the  weekly  premium  payment  plan. 

Sec.  202.     That  the  tax  shall  not  be  imposed  in  the 
case  of  the  trade  or  business  of  a  foreign  corporation 
or  partnership  or  a  non-resident  alien  individual,  the 
net  income  of  which  trade  or  business  during  the  tax 
able  year  is  less  than  $3,000. 

Deductions  allowed  domestic  corporations. — Sec.  203. 
That  for  the  purposes  of  this  title  the  deduction  shall 
be  as  follows,  except  as  otherwise  in  this  title  provided — 

(a)  In  the  case  of  a  domestic  corporation,  the  sum  of 
(1)  an  amount  equal  to  the  same  percentage  of  the 
invested  capital  for  the  taxable  year  which  the  average 
amount  of  the  annual  net  income  of  the  trade  or  busi- 
ness during  the  pre-war  period  was  of  the  invested 
capital  for  the  pre-war  period  (but  not  less  than  seven 
or  more  than  nine  per  centum  of  the  invested  capital 
for  the  taxable  year),  and  (2)  $3,000; 

Deductions  allowed  domestic  partnerships,  citizens  and 
residents. — (b)  In  the  case  of  a  domestic  partnership  or 
of  a  citizen  or  resident  of  the  United  States,  the  sum  of 
(1)  an  amount  equal  to  the  same  percentage  of  the  in- 
vested capital  for  the  taxable  year  which  the  average 
amount  of  the  annual  net  income  of  the  trade  or  busi- 
ness during  the  pre-war  period  was  of  the  invested 
capital  for  the  pre-war  period  (but  not  less  than  seven 
or  more  than  nine  per  centum  of  the  invested  capital 
for  the  taxable  year),  and  (2)  $6,000; 

Deductions  allowed  foreign  corporations,  partnerships  and 
non-resident  aliens. — (c)  In  the  case  of  a  foreign  corpor- 
ation or  partnership  or  of  a  non-resident  alien  individ- 
ual,  an    amount   ascertained   in   the    same   manner   as 


WAR    EXCESS    PROFITS    TAX    LAW  629 

provided  in  subdivisions  (a)  and  (b)  without  any 
exemption  of  $3,000  or  $6,000. 

Deductions  when  income  of  pre-war  period  cannot  satis- 
factorily be  determined. — (d)  If  the  Secretary  of  the 
Treasury  is  unable  satisfactorily  to  determine  the  aver- 
age amount  of  the  annual  net  income  of  the  trade  or 
business  during  the  pre-war  period,  the  deduction  shall 
be  determined  in  the  same  manner  as  provided  in  section 
two  hundred  and  live. 

Deductions  allowed  when  corporation  or  partnership  not 
in  existence  in  pre-war  period. — Sec.  204.  That  if  a  cor- 
poration or  partnership  was  not  in  existence,  or  an 
individual  was  not  engaged  in  the  trade  or  business, 
during  the  whole  of  any  one  calendar  year  during  the 
pre-war  period,  the  deduction  shall  be  an  amount  equal 
to  eight  per  centum  of  the  invested  capital  for  the  tax- 
able year,  plus  in  the  case  of  a  domestic  corporation 
$3,000,  and  in  the  case  of  a  domestic  partnership  or  a 
citizen  or  resident  of  the  United  States  $6,000. 

Reorganized  business  considered  continuous. — A  trade  or 
business  carried  on  by  a  corporation,  partnership,  or 
individual,  although  formally  organized  or  reorganized 
on  or  after  January  second,  nineteen  hundred  and  thir- 
teen, which  is  substantially  a  continuation  of  a  trade 
or  business  carried  on  prior  to  that  date,  shall,  for  the 
purposes  of  this  title,  be  deemed  to  have  been  in  ex- 
istence prior  to  that  date,  and  the  net  income  and  in- 
vested capital  of  its  predecessor  prior  to  that  date  shall 
be  deemed  to  have  been  its  net  income  and  invested 
capital. 

Deductions  allowed  when  no  pre-war  income  or  when 
percent  of  pre-war  income  was  low. — Sec.  205.  (a)  That 
if  the  Secretary  of  the  Treasury,  upon  complaint,  finds 
either  (1)  that  during  the  pre-war  period  a  domestic 
corporation  or  partnership,  or  a  citizen  or  resident  of 
the  United  States,  had  no  net  income  from  the  trade  or 
business,  or  (2)  that  during  the  pre-war  period  the  per- 


630        INCOME    AND    FEDERAL    TAX    REPORTS 

centage,  which  the  net  income  was  of  the  invested  capi- 
tal, was  low  as  compared  with  the  percentage,  which 
the  net  income  during  such  period  of  representative 
corporations,  partnerships,  and  individuals,  engaged  in 
a  like  or  similar  trade  or  business,  was  of  their  invested 
capital,  then  the  deduction  shall  be  the  sum  of  (1)  an 
amount  equal  to  the  same  percentage  of  its  invested 
capital  for  the  taxable  year  which  the  average  deduc- 
tion (determined  in  the  same  manner  as  provided  in 
section  two  hundred  and  three,  without  including  the 
$3,000  or  $6,000  therein  referred  to)  for  such  year  of 
representative  corporations,  partnerships  or  individuals, 
engaged  in  a  like  or  similar  trade  or  business,  is  of  their 
average  invested  capital  for  such  year,  plus  (2)  in  the 
case  of  a  domestic  corporation  $3,000,  and  in  the  case 
of  a  domestic  partnership  or  a  citizen  or  resident  of  the 
United  States  $6,000. 

The  percentage  which  the  net  income  was  of  the  in- 
vested capital  in  each  trade  or  business  shall  be  deter- 
mined by  the  Commissioner  of  Internal  Eevenue,  in 
accordance  with  the  regulations  prescribed  by  him,  with 
the  approval  of  the  Secretary  of  the  Treasury.  In  the 
case  of  a  corporation  or  partnership  which  has  fixed  its 
own  fiscal  year,  the  percentage  determined  by  the  cal- 
endar year  ending  during  such  fiscal  year  shall  be  used. 

(b)  The  tax  shall  be  assessed  upon  the  basis  of  the 
deduction  determined  as  provided  in  section  two  hun- 
dred and  three,  but  the  taxpayer  claiming  the  benefit 
of  this  section  may  at  the  time  of  making  the  return  file 
a  claim  for  abatement  of  the  amount  by  which  the  tax 
so  assessed  exceeds  a  tax  computed  upon  the  basis  of 
the  deduction  determined  as  provided  in  this  section. 
In  such  event,  collection  of  the  part  of  the  tax  covered 
by  such  claim  for  abatement  shall  not  be  made  until 
the  claim  is  decided,  but  if  in  the  judgment  of  the  Com- 
missioner of  Internal  Revenue  the  interests  of  the 
United  States  would  be  jeopardized  thereby  he  may  re- 


WAR   EXCESS   PROFITS    TAX    LAW  631 

quire  the  claimant  to  give  a  bond  in  such  amount  and 
with  such  sureties  as  the  Commissioner  may  think  wise, 
to  safeguard  such  interests,  conditioned  for  the  payment 
of  any  tax  found  to  be  due,  with  the  interest  thereon, 
and  if  such  bond,  satisfactory  to  the  Commissioner,  is 
not  given  within  such  time  as  he  prescribes,  the  full 
amount  of  tax  assessed  shall  be  collected  and  the  amount 
overpaid,  if  any,  shall  upon  final  decision  of  the  appli- 
cation be  refunded  as  a  tax  erroneously  or  illegally 
collected. 

Ascertainment  of  net  income  of  a  corporation  for  pre-war 
period. — Sec.  206.  That  for  the  purposes  of  this  title 
the  net  income  of  a  corporation  shall  be  ascertained 
and  returned 

(a)  for  the  calendar  years  nineteen  hundred  and 
eleven  and  nineteen  hundred  and  twelve  upon  the  same 
basis  and  in  the  same  manner  as  provided  in  section 
thirty-eight  of  the  Act  entitled  "An  Act  to  provide 
revenue,  equalize  duties,  and  encourage  the  industries 
of  the  United  States,  and  for  other  purposes,"  approved 
August  fifth,  nineteen  hundred  and  nine,  except  that 
income  taxes  paid  by  it  within  the  year  imposed  by  the 
authority  of  the  United  States  shall  be  included; 

(b)  for  the  calendar  year  nineteen  hundred  and  thir- 
teen upon  the  same  basis  and  in  the  same  manner  as 
provided  in  section  II  of  the  Act  entitled  "An  Act  to 
reduce  tariff  duties  and  to  provide  revenue  for  the 
Government,  and  for  other  purposes,"  approved  October 
third,  nineteen  hundred  and  thirteen,  except  that  in- 
come taxes  paid  by  it  within  the  year  imposed  by  the 
authority  of  the  United  States  shall  be  included,  and 
except  that  the  amounts  received  by  it  as  dividends 
upon  the  stock  or  from  the  net  earnings  of  other  cor- 
porations, joint-stock  companies  or  associations,  or  in- 
surance companies,  subject  to  the  tax  imposed  by  sec- 
tion II  of  such  Act  of  October  third,  nineteen  hundred 
and  thirteen,  shall  be  deducted;  and 


632  INCOME    AND    FEDERAL    TAX   REPORTS 

(c)  for  the  taxable  year  upon  the  same  basis  and  in 
the  same  manner  as  provided  in  Title  I  of  the  Act 
entitled  "An  Act  to  increase  the  revenue,  and  for 
other  purposes,"  approved  September  eighth,  nineteen 
hundred  and  sixteen,  as  amended  by  this  Act,  except 
that  the  amounts  received  by  it  as  dividends  upon  the 
stock  or  from  the  net  earnings  of  other  corporations, 
joint-stock  companies  or  associations,  or  insurance  com- 
panies, subject  to  the  tax  imposed  by  Title  I  of  such 
Act  of  September  eighth,  nineteen  hundred  and  sixteen, 
shall  be  deducted. 

Ascertainment  of  net  income  of  a  partnership  or  indi 
vidual  for  pre-war  period. — The  net  income  of  a  part- 
nership or  individual  shall  be  ascertained  and  returned 
for  the  calendar  years  nineteen  hundred  and  eleven, 
nineteen  hundred  and  twelve,  and  nineteen  hundred  and 
thirteen  and  for  the  taxable  year  upon  the  same  basis 
and  in  the  same  manner  as  provided  in  Title  I  of  such 
Act  of  September  eighth,  nineteen  hundred  and  sixteen, 
as  amended  by  this  Act,  except  that  the  credit  allowed 
by  subdivision  (b)  of  section  five  of  such  Act  shall  be 
deducted. 

There  shall  be  allowed  (a)  in  the  case  of  a  domestic 
partnership  the  same  deductions  as  allowed  to  indi- 
viduals in  subdivision  (a)  of  section  five  of  such  Act 
of  September  eighth,  nineteen  hundred  and  sixteen,  as 
amended  by  this  Act;  and 

(b)  in  the  case  of  a  foreign  partnership  the  same 
deductions  as  allowed  to  individuals  in  subdivision  (a) 
of  section  six  of  such  Act  as  amended  by  this  Act. 

Definition  of  "invested  capital." — Sec.  207.  That  as 
used  in  this  title,  the  term  "invested  capital"  for  anv 
year  means  the  average  invested  capital  for  the  year, 
as  defined  and  limited  in  this  title,  averaged  monthly. 

As  used  in  this  title  "invested  capital"  does  not 
include  stocks,  bonds  (other  than  obligations  of  the 
United  States),  or  other  assets,  the  income  from  which 


WAR   EXCESS    PROFITS    TAX    LAW  633 

is  not  subject  to  the  tax  imposed  by  this  title,  nor 
money  or  other  property  borrowed,  and  means,  subject 
to  the  above  limitations; 

"Invested  capital"  of  a  corporation  or  partnership. — 
(a)  In  the  case  of  a  corporation  or  partnership: 
(1)  actual  cash  paid  in,  (2)  actual  cash  value 
of  tangible  property  paid  in  other  than  cash,  for 
stock  or  shares  in  such  corporation  or  partner- 
ship, at  the  time  of  such  payment  (but  in  case 
such  tangible  property  was  paid  in  prior  to  January 
first,  nineteen  hundred  and  fourteen,  the  actual  cash 
value  of  such  property  as  of  January  first,  nineteen 
hundred  and  fourteen,  but  in  no  case  to  exceed  the  par 
value  of  the  original  stock  or  shares  specifically  issued 
therefor),  and  (3)  paid  in  or  earned  surplus  and  un- 
divided profits  used  or  employed  in  the  business,  ex- 
clusive of  undivided  profits  earned  during  the  taxable 
year:  Provided,  That  (a)  the  actual  cash  value  of 
patents  and  copyrights  paid  in  for  stock  or  shares  in 
such  corporation  or  partnership,  at  the  time  of  such 
payment,  shall  be  included  as  invested  capital,  but  not  to 
exceed  the  par  value  of  such  stock  or  shares  at  the  time 
of  such  payment,  and  (b)  the  good  will,  trade  marks, 
trade  brands,  the  franchise  of  a  corporation  or  part- 
nership, or  other  intangible  property,  shall  be  included 
as  invested  capital  if  the  corporation  or  partnership 
made  payment  bona  fide  therefor  specifically  as  such  in 
cash  or  tangible  property,  the  value  of  such  good  will, 
trade  mark,  trade  brand,  franchise,  or  intangible  prop- 
erty, not  to  exceed  the  actual  cash  or  actual  cash  value 
of  the  tangible  property  paid  therefor  at  the  time  of 
such  payment;  but  good  will,  trade  marks,  trade 
brands,  franchise  of  a  corporation  or  partnership,  or 
other  intangible  property,  bona  fide  purchased,  prior  to 
March  third,  nineteen  hundred  and  seventeen,  for  and 
with  interests  or  shares  in  a  partnership  or  for  and 
with    shares    in    the    capital    stock    of    a    corporation 


634  INCOME   AND    FEDERAL    TAX   REPORTS 

(issued  prior  to  March  third,  nineteen  hundred  and 
seventeen),  in  an  amount  not  to  exceed,  on  March  third, 
nineteen  hundred  and  seventeen,  twenty  per  centum  of 
the  total  interests  or  shares  in  the  partnership  or  of 
the  total  shares  of  the  capital  stock  of  the  cor- 
poration, shall  be  included  in  invested  capital  at 
a  value  not  to  exceed  the  actual  cash  value  at  the  time 
of  such  purchase,  and  in  case  of  issue  of  stock  therefor 
not  to  exceed  the  par  value  of  such  stock; 

"Invested  capital"  of  individual. — (b)  In  the  case  of 
an  individual,  (1)  actual  cash  paid  into  the  trade  or 
business,  and  (2)  the  actual  cash  value  of  tangible 
property  paid  into  the  trade  or  business,  other  than 
cash,  at  the  time  of  such  payment  (but  in  case  such 
tangible  property  was  paid  in  prior  to  January  first, 
nineteen  hundred  and  fourteen,  the  actual  cash  value  of 
such  property  as  of  January  first,  nineteen  hundred 
and  fourteen),  and  (3)  the  actual  cash  value  of  patents, 
copyrights,  good  will,  trade  marks,  trade  brands,  fran- 
chises, or  other  intangible  property,  paid  into  the  trade 
or  business,  at  the  time  of  such  payment,  if  payment 
was  made  therefor  specifically  as  such  in  cash  or  tangi- 
ble property,  not  to  exceed  the  actual  cash  or  actual 
cash  value  of  the  tangible  property  bona  fide  paid 
therefor  at  the  time  of  such  payment. 

"Invested  capital"  of  foreign  corporation  or  partner- 
ship or  non-resident  alien. — In  the  case  of  a  foreign  corp- 
oration or  partnership  or  of  a  non-resident  alien  indi- 
vidual the  term  "invested  capital"  means  that  propor- 
tion of  the  entire  invested  capital,  as  defined  and  lim- 
ited in  this  title,  which  the  net  income  from  sources 
within  the  United  States  bears  to  the  entire  net  income. 

"Invested  capital"  in  case  of  reorganization,  consolida- 
tion or  change  of  ownership. — Sec.  208.  That  in  case  of 
the  reorganization,  consolidation,  or  change  of  owner- 
ship of  a  trade  or  business  after  March  third,  nine- 
teen hundred  and  seventeen,  if  an  interest  or  control  in 


WAR   EXCESS   PROFITS    TAX    LAW  635 

such  trade  or  business  of  fifty  per  centum  or  more  re- 
mains in  control  of  the  same  persons,  corporations,  as- 
sociations, partnerships,  or  any  of  them,  then  in  as- 
certaining the  invested  capital  of  the  trade  or  business 
no  asset  transferred  or  received  from  the  prior  trade 
or  business  shall  be  allowed  a  greater  value  than  would 
have  been  allowed  under  this  title  in  computing  the  in- 
vested capital  of  such  prior  trade  or  business  if  such 
asset  had  not  been  so  transferred  or  received,  unless 
such  asset  was  paid  for  specifically  as  such,  in  cash  or 
tangible  property,  and  then  not  to  exceed  the  actual 
cash  or  cash  value  of  the  tangible  property  paid  therefor 
at  the  time  of  such  payment. 

Assessment  of  tax  of  business  having  nominal  capital. 
— Sec.  209.  That  in  the  case  of  a  trade  or  business 
having  no  invested  capital  or  not  more  than  a  nominal 
capital  there  shall  be  levied,  assessed,  collected,  and 
paid,  in  addition  to  the  taxes  under  existing  law  and  un- 
der this  act,  in  lieu  of  the  tax  imposed  by  section  two 
hundred  and  one,  a  tax  equivalent  to  eight  per  centum 
of  the  net  income  of  such  trade  or  business,  in  excess  of 
the  following  deductions:  in  the  case  of  a  domestic 
corporation,  $3,000,  and  in  the  case  of  a  domestic  part- 
nership or  a  citizen  or  resident  of  the  United  States, 
$6,000;  in  the  case  of  all  other  trades  or  business,  no 
deduction. 

Deduction  when  invested  capital  cannot  satisfactorily 
be  determined. — Sec.  210.  That  if  the  Secretary  of  the 
Treasury  is  unable  in  any  case  satisfactorily  to  deter- 
mine the  invested  capital,  the  amount  of  the  deduction 
shall  be  the  sum  of  (1)  an  amount  equal  to  the  same 
proportion  of  the  net  income  of  the  trade  or  business 
received  during  the  taxable  year  as  the  proportion 
which  the  average  deduction  (determined  in  the  same 
manner  as  provided  in  section  two  hundred  and  three, 
without  including  the  $3,000  or  $6,000  therein  referred 
to)  for  the  same  calendar  year  of  representative  corpo 


636  INCOME    AND    FEDERAL    TAX   REPORTS 

rations,  partnerships,  and  individuals,  engaged  in  a  like 
or  similar  trade  or  business,  bears  to  the  total  net  in- 
come of  the  trade  or  business  received  by  such  corpora- 
tions, partnerships,  and  individuals,  plus  (2)  in  the  case 
of  a  domestic  corporation  $3,000,  and  in  the  case  of  a 
domestic  partnership  or  a  citizen  or  resident  of  the 
United  States  $6,000. 

For  the  purpose  of  this  section  the  proportion  be- 
tween the  deduction  and  the  net  income  in  each  trade 
or  business  shall  be  determined  by  the  Commissioner  of 
Internal  Eevenue  in  accordance  with  regulations  pre- 
scribed by  him,  with  the  approval  of  the  Secretary  of 
the  Treasury.  In  the  case  of  a  corporation  or  partner- 
ship which  has  fixed  its  own  fiscal  year,  the  proportion 
determined  for  the  calendar  year  ending  during  such 
fiscal  year  shall  be  used. 

Returns  to  be  rendered  by  partnerships. — Sec.  211. 
That  every  foreign  partnership  having  a  net  income  of 
$3,000  or  more  for  the  taxable  year,  and  every  domestic 
partnership  having  a  net  income  of  $6,000  or  more  for 
the  taxable  year,  shall  render  a  correct  return  of  the 
income  of  the  trade  or  business  for  the  taxable  year, 
setting  forth  specifically  the  gross  income  for  such  year, 
and  the  deductions  allowed  in  this  title.  Such  returns 
shall  be  rendered  at  the  same  time  and  in  the  same 
manner  as  is  prescribed  for  income-tax  returns  under 
Title  I  of  such  Act  of  September  eighth,  nineteen  hun- 
dred and  sixteen,  as  amended  by  this  Act. 

Administration  of  Act. — Sec.  212.  That  all  adminis- 
trative, special,  and  general  provisions  of  law,  including 
the  laws  in  relation  to  the  assessment,  remission,  col- 
lection, and  refund  of  internal-revenue  taxes  not  here- 
tofore specifically  repealed  and  not  inconsistent  with  the 
provisions  of  this  title  are  hereby  extended  and  made 
applicable  to  all  the  provisions  of  this  title  and  to 
the  tax  herein  imposed,  and  all  provisions  of  Title  I  of 


WAR    EXCESS   PROFITS    TAX    LAW  637 

such  Act  of  September  eighth,  nineteen  hundred  and  six- 
teen, as  amended  by  this  Act,  relating  to  returns  and 
payment  of  the  tax  therein  imposed,  including  penalties, 
are  hereby  made  applicable  to  the  tax  imposed  by  this 
title. 

Regulations. — Sec.  213.  That  the  Commissioner  of 
Internal  Bevenue,  with  the  approval  of  the  Secretary  of 
the  Treasury,  shall  make  all  necessary  regulations  for 
carrying  out  the  provisions  of  this  title,  and  may  re- 
quire any  corporation,  partnership  or  individual,  sub- 
ject to  the  provisions  of  this  title,  to  furnish  him  with 
such  facts,  data,  and  information  as  in  his  judgment  are 
necessary  to  collect  the  tax  imposed  by  this  title. 

Repeal  of  excess  profits  tax  law  of  March  3,  1917. — 
Sec.  214.  That  Title  II  (sections  two  hundred  to  two 
hundred  and  seven,  inclusive)  of  the  Act  entitled  "An 
Act  to  provide  increased  revenue  to  defray  the  expenses 
of  the  increased  appropriations  for  the  Army  and 
Navy,  and  the  extension  of  fortifications,  and  for  other 
purposes,"  approved  March  third,  nineteen  hundred  and 
seventeen,  is  hereby  repealed. 

Credit  for  taxes  paid  under  that  law. — Any  amount 
heretofore  or  hereafter  paid  on  account  of  the  tax  im- 
posed by  such  Title  II,  shall  be  credited  toward  the  pay- 
ment of  the  tax  imposed  by  this  title,  and  if  the  amount 
so  paid  exceeds  the  amount  of  such  tax  the  excess  shall 
be  refunded  as  a  tax  erroneously  or  illegally  collected. 

Amendment  of  Munition  Manufacturer's  Tax.  —  Sub- 
division (1)  of  section  three  hundred  and  one  of  such 
Act  of  September  eighth,  nineteen  hundred  and  sixteen, 
is  hereby  amended  so  that  the  rate  of  tax  for  the  taxable 
year  nineteen  hundred  and  seventeen  shall  be  ten  per 
centum  instead  of  twelve  and  one-half  per  centum,  as 
therein  provided. 

Subdivision  (2)  of  such  section  is  hereby  amended 
to  read  as  follows: 


638  INCOME   AND   FEDERAL    TAX   REPORTS 

"(2)    This  section  shall  cease  to  be  of  effect  on  and 
after  January  first,  nineteen  hundred  and  eighteen." 

TITLE  X. — Administrative  Provisions. 

TITLE  XIII.— General  Provisions. 
Invalidating  and  repealing  clause. — See  Sec.  1300. 
Approved  by  the  President,  October  3,  1917. 


CHAPTER  XXXIII 

EXCESS  PROFITS  TAX 

Importance  of  Excess  Profits  Tax. — The  tax  commonly 
known  as  the  Excess  Profits  tax,  or  more  properly  the 
War  Excess  Profits  tax,  is  really  more  important  than 
the  Income  tax.  True,  it  is  intended  to  be  a  means  of 
getting  special  revenues  to  meet  war  expenses,  and  is 
therefore  likely  to  be  temporary  only.  In  that  respect 
it  is  not  so  important  as  the  Income  tax,  which  will 
probably  in  one  form  or  another  be  used  indefinitely  to 
provide  revenues  to  meet  the  ordinary  expenses  of  run- 
ning the  government.  But  from  the  standpoint  of  the 
present  situation  the  Excess  Profits  tax  is  more  im- 
portant than  the  Income  tax.  In  the  first  place,  as  we 
have  seen,  the  Excess  Profits  tax  is  a  new  experiment 
in  American  taxation  practice.  In  the  next  place,  this 
tax  is  likely  to  yield  the  government  larger  revenues 
than  the  Income  tax.  Experts  of  the  Treasury  Depart- 
ment and  Senate  Finance  Committee,  shortly  after  the 
War  Eevenue  Law  was  enacted,  estimated  that  the  In- 
come tax  would  yield  $851,000,000  as  against  $1,000,000,- 
000  from  the  Excess  Profits  tax.  While  a  larger  num- 
ber of  individuals  and  businesses  will  pay  income  taxes, 
the  amounts  paid  by  leading  industrial  concerns  on  ac- 
count of  the  Excess  Profits  tax  will  be  prodigious  com- 
pared with  the  amounts  paid  for  the  Income  tax.  One 
statistician  estimated  that  the  United  States  Steel  Cor- 
poration would  pay  for  the  year  1917  about  $27,000,000 
for  the  Income  tax  and  $150,000,000  for  the  Excess 
Profits  tax — about  a  half  million  dollars  for  every  ordi- 
nary working  day. 

639 


640  INCOME   AND    FEDERAL    TAX    REPORTS 

But  another,  and  the  most  important,  reason  why  the 
Excess  Profits  tax  outshadows  the  Income  tax  is  that 
the  former  must  be  ascertained  before  the  latter  can  be 
computed.  Persons  subject  to  the  two  taxes  are  per- 
mitted to  subtract  from  their  income,  in  calculating  the 
net  income  on  which  they  will  pay  an  income  tax,  sums 
equal  to  the  amount  which  they  will  have  to  pay  for 
the  Excess  Profits  tax. 

General  statement  as  to  who  is  liable. — Liability  for  this 
tax  will  be  discussed  in  detail  a  little  farther  along,  but 
in  order  to  save  those  who  may  not  be  concerned  with 
this  tax  from  going  any  further  into  this  chapter  it 
may  be  stated  here  that,  in  general,  returns  must  be  filed, 
and  the  tax,  if  any,  be  paid  only  by  domestic  corpora- 
tions with  incomes  of  $3,000  a  year  or  more ;  by  domestic 
partnerships  with  incomes  of  $6,000  a  year  or  more ;  by 
citizens  or  residents  with  incomes  in  excess  of  $6,000  a 
year;  and  by  foreign  corporations,  foreign  partnerships 
and  non-resident  alien  individuals  with  a  net  income  of 
$3,000  a  year  or  more  from  sources  within  the  United 
States  (Regulations  41,  Art.  10,  11,  12). 

A  married  woman  who  is  a  sole  trader  or  is  entitled 
to  any  taxable  income  to  her  sole  and  separate  use,  may, 
for  purposes  of  the  Excess  Profits  tax,  make  a  separate 
return  in  the  same  manner  as  any  other  individual. 
(Regulations  41,  Art.  76.) 

A  summary  of  how  the  law  works. — The  reader  will 
get  a  much  better  idea  of  what  is  to  be  explained  if  he 
will  study  this  paragraph  carefully  and  try  to  under- 
stand the  purposes  of  the  Excess  Profits  Tax  law.  The 
explanation  of  various  terms  will  then  seem  reasonable 
and  not  merely  a  lot  of  disconnected  rules.  Remember, 
however,  that  the  explanation  here  given  is  only  of  gen- 
eral application ;  special  cases  are  taken  up  in  detail  later. 

The  Excess  Profits  Tax  of  October  3,  1917,  is  com- 
puted in  one  of  two  ways,  depending  upon  whether  the 


EXCESS   PROFITS    TAX  641 

trade  or  business  under  consideration  uses  invested  capi- 
tal or  does  not  use  invested  capital. 

Where  the  trade  or  business  has  no  invested  capital 
or  merely  a  nominal  capital,  the  tax  will  be  computed 
at  the  rate  of  8  per  cent  on  the  amount  of  net  income 
in  excess  of  a  specific  deduction. 

Where  the  trade  or  business  has  an  invested  capital 
the  tax  will  be  computed  at  graduated  rates  on  the 
amount  of  net  income  in  excess  of  a  deduction  based  in 
part  upon  the  rate  of  income  for  the  pre-war  period. 
The  same  income  cannot  be  taxed  on  both  bases  but  an 
individual  may  be  taxed  upon  different  portions  of  his 
income  on  different  bases. 

Leaving  aside  the  question  of  the  distinction  between 
invested  capital  and  nominal  capital,  which  is  discussed 
elsewhere  in  this  chapter,  we  must  consider  the  general 
working  of  the  graduated  tax. 

A  corporation,  we  will  say,  had  an  average  invested 
capital  of  $100,000  during  1911-1913  and  made  an  aver- 
age annual  profit  of  $50,000.  The  rate  of  profits  of  this 
concern  during  the  pre-war  period  was  50  per  cent,  but 
the  present  law  does  not  say  that  for  present  purposes 
only  a  rate  of  profit  above  50  per  cent  for  that  concern 
would  be  excessive,  subjecting  the  concern,  therefore,  to 
the  War  Excess  Profits  tax;  it  says,  that  the  maximum 
rate  exempt  under  any  circumstances  is  9  per  cent,  and 
that  any  income  will  be  subject  to  the  Excess  Profits 
tax  if  during  the  present  taxable  year  it  is  above  9  per 
cent  of  the  present  invested  capital,  no  matter  what 
the  rate  of  income  was  in  the  pre-war  period.  In  any 
event,  then,  this  concern  would  be  taxed  on  all  income 
in  excess  of  any  amount  equal  to  9  per  cent  on  its  in- 
vested capital  for  the  taxable  year.  (A  specific  deduc- 
tion of  $3,000  in  addition  to  the  9  per  cent  on  its  capital 
is  also  allowed.)  Having  then  determined  the  rate  of 
untaxed  profits  for  this  concern,  we  turn  to  its  present 
profits  to  see  what  they  are.    To  get  the  rate  of  profits 


642  INCOME   AND   FEDERAL    TAX   REPORTS 

we  must  know  the  amount  of  profits  and  the  capital  on 
which  those  profits  are  being  earned.  If  the  present 
rate  is  less  than  9  per  cent  the  concern  will  escape  the 
Excess  Profits  tax,  since  its  pre-war  rate  was  more  than 
9  per  cent,  and  in  such  a  case  9  per  cent  will  be  allowed 
as  a  deduction.  If,  on  the  other  hand,  its  pre-war  profits 
had  been  less  than  7  per  cent,  a  deduction  of  only  7 
per  cent  would  now  be  allowed.  There  are  two  ways 
in  which  the  rate  may  become  less  than  9  per  cent.  (1) 
If,  for  example,  the  company  had  the  same  net  income, 
$50,000,  but  if  its  invested  capital  had  increased  to  $700,- 
000,  the  profits  of  $50,000  would  amount  to  only  about 
7  per  cent  of  the  invested  capital.  It  therefore  is  to  the 
interest  of  the  owners  of  the  business  to  make  the  pres- 
ent invested  capital  appear  as  large  as  possible,  and 
conversely  it  is  to  the  interest  of  the  government  to 
limit  very  carefully  the  items  that  can  be  claimed  as 
invested  capital.  That,  we  shall  see,  is  the  chief  diffi- 
culty we  shall  have  to  meet  in  interpreting  this  law ;  the 
difficulty  of  determining  what  is  and  what  is  not  invested 
capital.  (2)  Or,  if  we  assume  that  the  capital  remained 
as  it  was  during  the  pre-war  period,  viz.,  $100,000,  but 
the  income  fell  to  $7,000,  again  the  rate  of  profits  would 
fall  below  the  pre-war  rate  of  9  per  cent  and  the  concern 
would  not  be  taxable.  In  such  a  case,  however,  we 
would  have  little  difficulty,  for  the  Excess  Profits  Tax 
law  provides  that  profits  are  to  be  determined  by  the 
detailed  rules  applicable  to  the  Income  tax.  That,  in 
very  brief  outline,  is  the  way  the  law  works.  Before 
we  examine  it  in  detail,  let  us  summarize  the  facts  that 
must  be  determined  before  the  tax  can  be  computed. 


GENERAL  DEFINITIONS 

Before  going  into  a  discussion  of  the  application  of 
the  law  it  would  be  advisable  to  define  some  of  the  terms 
that  will  be  used  throughout  this  chapter. 


EXCESS   PROFITS    TAX  '  J}43 

Corporation. — "Corporation"  is  denned  as  including 
joint-stock  companies  or  associations  and  insurance  com- 
panies and  limited  partnerships. 

United  States. — "United  States"  is  defined  by  the  law 
as  "only  the  States,  the  Territories  of  Alaska  and 
Hawaii,  and  the  District  of  Columbia." 

Domestic  Corporation.  —  A  domestic  corporation  is 
therefore  one  created  under  the  laws  of  the  United 
States,  or  of  any  State,  Territory  or  District  included 
in  the  definition  above. 

Foreign  Corporation.  —  A  foreign  corporation  is  one 
formed  under  the  laws  of  any  other  possession  of  the 
United  States  or  of  any  foreign  country.  Corporations 
organized  in  Porto  Rico,  the  Philippines,  or  the  Canal 
Zone  are  therefore  to  be  considered  "foreign." 

Exempt  concerns.  —  Corporations  which  are  exempt 
from  the  Income  tax  are  also  exempt  from  the  Excess 
Profits  tax.  Partnerships  carrying  on  the  same  business 
or  coming  within  the  same  description,  and  individuals 
to  the  extent  they  carry  on  or  do  the  same  kind  of 
business  or  come  within  the  same  description  as  that  of 
an  exempt  corporation  are  also  exempt. 

Foreign  partnership. — Domestic  and  foreign  partner- 
ships are  defined  in  the  same  way  as  are  foreign  and 
domestic  corporations.  It  is  difficult  to  decide  whether 
a  partnership  is  organized  in  the  United  States  or  in 
some  foreign  country.  When,  for  instance,  is  a  part- 
nership organized  or  created  under  the  laws,  say  of  Eng- 
land! It  may  do  business  both  in  the  United  States 
and  in  England,  and  one  of  its  partners  may  live  here 
and  one  in  England.  Moreover,  one  may  have  signed  a 
duplicate  copy  of  partnership  articles  of  agreement  here, 
and  the  other  may  have  signed  a  duplicate  copy  in  Eng- 
land. Two  sets  of  books  may  be  kept,  one  here  and  one 
in  England.  The  office  here  may  be  just  as  important 
but  no  more  so  than  the  one  in  England.  What  is  the 
test!    In  the  last  analysis  the   Treasury  Department 


644  INCOME   AND    FEDERAL    TAX   REPORTS 

must  solve  this  question.  The  tendency  undoubtedly 
will  be  to  class  such  partnerships  as  domestic. 

Pre-war  period. — The  term  pre-war  period  means  the 
calendar  years  1911,  1912,  1913  (the  rate  of  earnings  for 
which  period  form  the  bases  of  the  amount  of  income 
exempt  from  the  tax),  or  if  the  concern  was  not  en- 
gaged in  trade  or  business  during  the  whole  of  such 
three  years,  then  as  many  of  such  years  during  the 
whole  of  which  the  concern  was  engaged  in  trade  or 
business. 

Trade  or  business. — The  terms  "trade"  and  "business" 
are  defined  to  include  professions  and  occupations. 

Net  income. — The  term  "net  income"  as  used  in  refer- 
ence to  foreign  corporations  or  partnerships  or  non- 
resident alien  individuals  means  the  net  income  received 
from  sources  within  the  United  States. 

THE   8   PER   CENT  TAX 

The  8  per  cent  Excess  Profits  tax. — As  stated  before, 
individuals,  partnerships,  or  corporations  engaged  in 
trade  or  business  not  employing  any  invested  capital  or 
employing  only  a  nominal  capital  are  subject  to  a  tax 
•at  the  rate  of  8  per  cent  on  their  net  income  in  excess 
of  a  certain  specific  deduction.  A  general  statement  of 
those  liable  to  pay  the  tax  is  found  on  page  640. 

Income  subject  to  the  tax. — The  income  subject  to  this 
tax  includes  salaries,  wages,  commissions,  bonuses  and 
profits  from  businesses  not  employing  invested  capital. 
Non-resident  aliens,  partnerships  and  corporations  are 
taxed  on  such  portion  of  their  net  income  as  is  from 
sources  within  the  United  States.  Individuals  and  part- 
nerships, as  explained  later,  may  pay  themselves  salaries 
for  services  rendered,  and  such  salaries  would  come 
under  this  tax. 

In  the  case  of  a  corporation  or  partnership,  all  income 
from  whatever  source  derived  is  deemed  to  be  from  its 
trade  or  business  and  is  therefore  subject  to  the  tax 


EXCESS   PROFITS    TAX  645 

(after  deducting  $3,000  or  $6,000,  as  the  case  may  be, 
and  income  exempt  from  taxation).  In  the  case  of  an 
individual,  however,  only  such  income  is  subject  to  this 
tax  as  is  derived  from 

"all  his  activities  for  gain,  profit  or  livelihood  entered  into  with  sufficient 
frequency,  or  occupying  such  portion  of  his  time  or  attention  as  to  con- 
stitute a  vocation,  including  occupations  and  professions.  When  such 
activities  constitute  a  vocation  they  shall  be  construed  to  be  a  trade  or 
business  whether  continuously  carried  on  during  the  taxable  year  or  not, 
and  all  the  income  arising  therefrom  shall  be  included  in  his  return  for 
excess-profits  tax. 

"In  the  following  cases  the  gain  or  income  is  not  subject  to  excess  profits 
tax,  and  the  capital  from  which  such  gain  or  income  is  derived  shall  not 
be  included  in  'invested  capital':  (a)  Gains  or  profits  from  transactions 
entered  into  for  profit,  but  which  are  isolated,  incidental,  or  so  infrequent 
as  not  to  constitute  an  occupation,  and  (b)  the  income  from  property  aris- 
ing merely  from  its  ownership,  including  interest,  rent,  and  similar  income 
from  investments  except  in  those  cases  in  which  the  management  of  such 
investments  really  constitutes  a  trade  or  business."     (Reg.  41,  Art.  8.) 

Exempt  income. — Fees  or  compensation  received  by 
officers  and  employees  under  the  United  States,  or  any 
State,  Territory,  or  the  District  of  Columbia,  or  any 
local  subdivision  thereof,  for  work  as  such  officers  or 
employees,  is  exempt.  It  is  held  that  Congressmen 
and  Senators  are  not  such  officers  or  employees  of  the 
United  States ;  their  salaries,  therefore,  are  not  exempt. 

Income  exempt  from  taxation  under  section  4  of  the 
Income  Tax  law  of  1916  (see  page  39)  is  also  exempt. 

Income  derived  from  the  business  of  life,  health  and 
accident  insurance  combined  in  one  policy  issued  on 
the  weekly  premium  payment  plan  is  exempt. 

Specific  Exemptions. — Domestic  corporations  are  al- 
lowed an  exemption  of  $3,000.  Domestic  partnerships 
and  individuals  are  allowed  an  exemption  of  $6,000. 
No  exemption  is  allowed  to  non-resident  alien  individ- 
uals or  to  foreign  partnerships  or  corporations. 

Importance  of  determining  what  is  nominal  capital. — We 
saw  that  the  tax  was  computed  in  two  different  ways, 


646  INCOME   AND   FEDERAL    TAX   REPORTS 

one  method  being  used  for  concerns  with  no  capital  or 
with  only  nominal  capital,  and  the  other  method  for 
concerns  with  invested  capital.  Nominal  capital  is  de- 
fined as  meaning  "in  general  a  small  or  negligible  cap- 
ital whose  use  in  a  particular  trade  or  business  is  in- 
cidental." Concerns,  therefore,  are  divided  into  two 
classes — Class  A  being  those  with  no  capital  or  only- 
nominal  capital,  and  Class  B  being  those  with  "invested 
capital."  This  distinction  is  fundamental,  and  the  tax- 
payer should  determine  at  the  outset  whether  he  belongs 
to  Class  A  or  Class  B.  Corporations  or  partnerships 
must  be  in  one  class  or  the  other.  Individuals  may  be 
in  both  classes,  i.e.,  they  may  be  required  to  file  two  re- 
turns, one  for  one  income,  to  be  taxed  under  Class  A, 
and  one  for  the  other  income,  to  be  taxed  under  Class  B. 
Class  A  concerns  pay  a  flat  8  per  cent  tax,  while  the 
Class  B  concerns  pay  the  graduated  tax. 

When  does  a  concern  have  no  capital,  or  only  nominal 
capital? — The  Treasury  Begulations  make  it  quite  plain 
that  the  nature  of  the  business  carried  on  by  a  con- 
cern is  the  one  most  important  factor  in  determining 
whether  it  belongs  to  Class  A  or  Class  B.  Since  the 
Government  is  likely  to  derive  more  revenue  from  a 
concern  by  placing  it  in  Class  B  than  in  Class  A,  the 
regulations  are  so  framed  that  doubts  as  to  classification 
are  generally  settled  by  putting  the  concern  in  Class  B, 
but  the  taxpayer  will  do  well  to  study  the  rules  care- 
fully before  coming  to  a  conclusion. 

In  Class  A,  it  was  intended  by  the  law  to  put  con- 
cerns that  depended  chiefly  on  the  personal  service  and 
ability  of  the  owners.  The  mere  fact  that  a  concern 
sells  or  renders  personal  service  instead  of  making  and 
selling  goods  will  not  bring  the  concern  to  Class  A  un- 
less the  earnings  of  the  concern  "are  to  be  ascribed 
primarily  to  the  activities  of  the  owners."  A  law  firm 
or  an  accounting  firm  has  nominal  capital  only,  because 
the  reputation  of  the  partners  is  the  chief  element  of 


EXCESS   PROFITS    TAX  647 

earnings,  and  this  would  seem  to  be  true  if  the  num- 
ber of  employees  is  many  times  as  great  as  the  number 
of  the  partners,  and  even  if  the  concern  is  required  to 
maintain  a  fairly  large  capital  in  the  form  of  bank  bal- 
ances to  pay  salaries  and  wages.  (Reg.  41,  Art.  72.) 
Moreover,  if  a  firm,  corporation  or  individual  renders 
personal  services  or  professional  services  and  employs 
capital  in  the  form  of  office  furniture,  accommodations 
and  equipment,  it  will  not  for  that  reason  be  taken  out 
of  Class  A.  Nor  does  the  fact  that  the  concern  hap- 
pens to  be  organized  as  a  corporation  affect  its  status. 
The  chief  question  to  ask,  is,  are  the  earnings  of  the 
concerns  rendering  the  service  such  as  is  being  rendered 
by  this  concern  ordinarily  and  necessarily  procured 
primarily  through  the  activities  of  their  owners? 

Amount  of  capital  employed  not  a  determining  factor  in 
classifying  concerns. — A  firm  with  large  capital,  then, 
may  come  under  Class  A  while  another  with  small  cap- 
ital may  come  under  Class  B.  The  Regulations  say 
"Business  concerns  which  render  professional  or  per- 
sonal service  .  .  .  shall  not  be  taken  out  of  (Class  A) 
because  of  the  size  of  the  capital,  if  the  employment  of 
capital  is  necessitated  by  delay  or  irregularity  in  the 
receipt  of  fees,  etc."  If  the  concern  is  one  of  the  kind 
that  ordinarily  falls  in  Class  B,  but  for  some  reason 
its  "invested  capital,"  as  defined  by  the  law,  is  "seri- 
ously disproportionate  to  the  taxable  income,"  it  will, 
nevertheless,  be  left  in  Class  B,  but  it  will  be  treated 
as  "one,  the  amount  of  whose  invested  capital  the  Sec- 
retary of  the  Treasury  cannot  determine."  (Reg.  41, 
Art.  52  and  74,  and  also  see  pages  689,  693.) 

When  concerns  will  be  deemed  not  to  have  nominal  cap- 
ital.— Some  general  rules  have  been  laid  down  for  the 
guidance  of  concerns,  all  of  which  state  conditions  which 
may  exist  without  bringing  a  concern  into  Class  A. 

(a)  A  corporation  may,  during  a  taxable  year,  because 
of  war  conditions  or  because  of  any  other  circumstances 


648  INCOME    AND    FEDERAL    TAX    REPORTS 

have  income  quite  disproportionate  to  the  invested  cap- 
ital. The  purpose  of  the  law  was  to  get  at  precisely 
that  income,  and  such  concerns  therefore  will  not  be  per- 
mitted to  claim  that  they  belong  in  Class  A.  "In  the 
determination  of  doubtful  cases,  stress  will  be  laid  upon 
the  normal  of  net  income  to  capital  during  pre-war 
years,"  and,  it  may  be  proper  to  add,  this  applies  to 
the  relation  of  income  to  capital  during  pre-war  years 
of  concerns  engaged  in  the  same  line  of  business  and 
not  alone  to  the  particular  concern  in  question. 

(b)  A  concern  will  not  be  taken  out  of  Class  B  be- 
cause its  capitalisation  (stocks  and  bonds  of  a  corpora- 
tion, or  stated  capital  of  a  partnership,  the  liability 
item  of  capital  invested,  not  including  surplus)  is  nomi- 
nal. If  they  employ  a  substantial  capital,  that  is,  if 
they  use  a  large  amount  of  capital  assets,  and  do  not 
render  personal  or  professional  services,  they  will  be 
taxed  in  Class  B.  The  excess  of  capital  assets  over 
capitalization,  we  shall  see,  may  be  taken  care  of  by  in- 
cluding, under  certain  restrictions,  the  surplus  in  the 
amount  of  "invested  capital." 

(c)  The  mere  fact,  that  a  concern,  that  would  other- 
wise be  included  in  Class  B,  has  invested  a  large  part 
of  its  assets  in  stocks  or  bonds  (other  than  obligations 
of  the  United  States)  or  in  other  assets  the  income  from 
which  is  not  subject  to  the  Excess  Profits  tax,  and  there- 
fore has  but  a  nominal  amount  of  what  is  technically 
defined  as  "invested  capital,"  does  not  bring  this  con- 
cern into  Class  A;  it  must  seek  redress  by  claiming  the 
advantage  of  the  rule  in  respect  to  concerns  whose  cap- 
ital the  Secretary  of  the  Treasury  has  difficulty  in  de- 
termining.    (See  page  693,  post.) 

(d)  A  concern  is  not  to  be  put  in  Class  A  merely  be- 
cause most  of  its  capital  was  acquired  through  borrowed 
funds. 

(e)  A  concern  whose  original  capital  was  small  but 
has  appreciated  in  value,  and  whose  "invested  capital," 


EXCESS   PROFITS    TAX  649 

as  defined  by  the  law,  therefore  is  relatively  small,  will 
not  for  that  reason  be  taken  out  of  Class  B. 

(f)  A  concern  with  intangible  assets  "built  up  or  de- 
veloped by  expenditures  which  have  been  regularly  de- 
ducted as  items  of  current  expense,"  will  not  be  per- 
mitted to  claim  that  it  shall  be  taxed  in  Class  A,  merely 
because  its  "invested  capital,"  as  the  law  defines  it,  is 
relatively  small.  For  example,  a  corporation  may  spend 
$500,000  a  year  in  advertising,  and  have  an  item  of 
good-will  easily  worth  several  million  —  worth  several 
million  because  it  could  sell  that  good-will  for  that  price. 
This  good-will  is  not  included  as  "invested  capital"  un- 
der the  law,  because  it  has  not  been  paid  for  with  stock, 
cash,  or  tangible  property.     (See  page  685,  et  seq.) 

In  cases  (d),  (e),  and  (f),  while  the  concern  will  be 
classed  in  Class  B,  it  may  still  claim  the  benefit  of  Sec- 
tion 210  respecting  concerns  whose  capital  cannot  satis- 
factorily be  established.     (Beg.  41,  Arts.  52  and  74.) 

Brokers  and  commission  merchants. — The  Treasury  Reg- 
ulations  make  a  fine  distinction  between  brokers  and 
commission  merchants.  Technically  speaking,  the  dif- 
ference between  a  broker  and  a  commission  merchant  is 
rather  shadowy.  Both  sell  goods  for  others,  but  the 
broker  does  not  get  possession  of  the  goods  before  the 
sale,  while  the  commission  merchant  does  get  possession. 
But  men  frequently  term  themselves  brokers  while  in 
fact  they  sometimes  do  get  possession  of  the  goods  be- 
fore the  sale  is  made.  For  example,  stock  brokers  are 
frequently  given  certificates  of  stock  to  sell. 

A  careful  examination  of  this  regulation  leads  to  this 
conclusion:  if  a  broker  uses  capital  to  finance  his  busi- 
ness operations,  he  will  be  deemed  to  be  employing  cap- 
ital and  therefore  comes  in  Class  B ;  if,  however,  he  uses 
capital  to  finance  himself,  i.e.,  to  pay  salaries  of  his  em- 
ployees, to  pay  rent  of  an  office,  etc.,  he  will  come  under 
Class  A.  (The  Regulation  reads:  "Agents  and  brokers 
requiring  and  using  no  capital  or  merely  a  nominal  cap- 


650  INCOME   AND    FEDERAL    TAX    REPORTS 

ital  in  their  business  are  taxable  under  Class  A,  but 
commission  houses  regularly  employing  a  substantial 
amount  of  capital,  whether  to  lend  to  principals  or  to 
carry  goods  on  their  own  account,  are  not  deemed  to  be 
agents  or  brokers  and  are  taxable  under  the  provisions 
of  Article  16  [relating  to  Class  B]." 

Returns  Required.  —  Citizens,  and  residents  of  the 
United  States,  non-resident  aliens,  and  corporations, 
both  foreign  and  domestic,  are  required  to  make  re- 
turns of  their  net  income  under  the  provisions  of  the 
Income  Tax  Law.  The  calculation  of  this  8  per  cent 
Excess  Profits  tax  will  undoubtedly  be  made  on  the 
regular  Income  Tax  form  (as  in  the  case  of  citizens  and 
residents  of  the  United  States  where  the  Excess  Profits 
tax  is  calculated  on  Form  1040,  the  standard  Income 
Tax  form.)     (See  footno.te,  p.  663,  post.) 

No  returns  were  required  of  partnerships,  either  do- 
mestic or  foreign,  under  the  Income  Tax  Law,  the  tax 
being  levied  on  the  individual  partners. 

For  the  purposes  of  the  Excess  Profits  tax,  however, 
a  partnership  is  treated  as  separate  and  distinct  from 
its  members,  and  the  partnership  as  such  must  file  a 
separate  return,  provided  its  net  income  is  $6,000  or 
more  if  domestic  or  $3,000  if  foreign. 

It  will  be  noticed  that  while  foreign  partnerships  are 
not  given  any  exemption,  they  are  not  required  to  file 
a  return  unless  their  net  income  is  $3,000  or  more. 
This  provision  is  evidently  an  error  on  the  part  of 
Congress,  as  the  difference  of  one  cent  in  the  income 
($2,999.99  to  $3,000)  would  cost  the  partnership  a  tax 
of  $240.  Until  regulations  are  issued  to  the  contrary, 
no  returns  will  be  required  of  non-resident  partnerships 
unless  their  income  is  $3,000  or  more. 

THE  GRADUATED  EXCESS  PROFITS  TAX 

Who  is  liable  to  pay  the  tax. — An  individual  or  con- 
cern, falling  within  one  of  the  classes  mentioned  on  p. 


EXCESS   PROFITS    TAX  651 

640,  and  employing  invested  capital,  is  subject  to  this 
tax. 

It  must  be  remembered  that  non-resident  aliens  are 
liable  to  the  tax  only  on  their  income  from  sources 
within  the  United  States.  The  "United  States,"  it  must 
be  remembered,  for  the  purpose  of  this  tax,  includes, 
besides  the  continental  territory  including  Alaska,  only 
Hawaii,  so  that  residents  of  Porto  Eico  or  the  Philip- 
pines are  to  be  looked  upon  as  foreigners,  and  income 
derived  from  one  of  those  islands  is  income  derived 
from  outside  the  United  States. 

What  income  is  to  be  included. — Inasmuch  as  a  cor- 
poration or  partnership  is  evidently  organized  for  the 
purpose  of  engaging  in  business,  all  its  activities  are 
held  to  be  business.  Partnerships  and  corporations  are 
therefore  taxed  on  their  entire  net  income  from  all  tax- 
able sources.  The  income  of  an  individual,  however,  is 
to  be  limited,  as  stated  on  p.  645. 

It  will  be  noticed  that  the  law  (sec.  201)  provides 
that  wherever  a  partnership  or  corporation  (not  an  in- 
dividual) is  engaged  in  several  trades  or  businesses,  all 
the  trades  or  businesses  in  which  it  is  engaged  "shall 
be  treated  as  a  single  trade  or  business,  and  all  its  in- 
come from  whatever  source  derived  shall  be  deemed  to 
be  received  from  such  trade  or  business."  Its  entire 
income  will  be  held  to  be  subject  to  the  same  tax  rate; 
so  that  if  a  corporation  or  partnership  employed  "in- 
vested capital"  in  one  part  of  its  business,  and  no  cap- 
ital in  another  part,  all  its  income  will  be  subject  to  the 
graduated  Excess  Profits  tax.  In  the  case  of  an  indi- 
vidual, however,  the  net  income  may  be  classified  in  two 
groups :  Class  A,  income  derived  from  business  or  trade 
employing  no  invested  capital  (subject  to  8  per  cent 
tax),  and  Class  B,  income  derived  from  trade  or  busi- 
ness having  invested  capital  (subject  to  the  graduated 
tax).  (Eeg.  41,  Art.  14.)  The  total  income  from  each 
class  is  then  reported  separately. 


652  INCOME   AND    FEDERAL    TAX   REPORTS 

Summary  of  facts  to  be  ascertained  before  the  amount  of 
tax  can  be  determined. — We  shall  need  to  ascertain  these 
facts  in  order  to  determine  the  amount  of  the  excess 
profits  tax: 

1.  The  rate  of  pre-war  profits,  which  necessitates  as- 
certaining 

a.  pre-war  net  income. 

b.  pre-war  invested  capital  on  which  this  income 
was  applied  to  find  the  rate  of  profits. 

(Incidentally,  it  may  be  mentioned  here,  it  is  neces- 
sary to  determine  whether  the  rate  of  profits  so  ascer- 
tained is  fairly  comparable  with  the  rate  of  profits 
earned  during  the  same  period  by  other  concerns  in 
the  same  general  line  of  business  or  whether  the  rate 
of  the  given  concern  is  subnormal.  If  it  is  subnormal 
(i.e.,  lower  by  one  per  cent  or  more  than  the  normal 
rate),  its  own  rate  of  profits  is  discarded  and  the  normal 
rate  is  used  in  its  place.  Moreover,  if  the  rate  of 
profits  for  the  pre-war  period  was  less  than  7  per  cent, 
7  per  cent  will  be  used  as  the  rate,  or  if  the  rate  was 
more  than  9  per  cent,  9  per  cent  will  be  used  as  the 
rate.) 

2.  The  net  income  in  the  taxable  year. 

3.  The  invested  capital  in  the  taxable  year. 

4.  The  specific  exemption  to  which  the  taxpayer  is 
entitled. 

5.  A  sum  (known  as  the  deduction),  found  by  apply- 
ing the  rate  of  pre-war  profits  (see  above)  to  the  in- 
vested capital  of  the  concern  in  the  taxable  year. 

The  tax  then  will  be  applied  to  the  amount  of  net 
income  in  the  taxable  year,  less  the  deduction  and  the 
specific  exemption.  The  rate  of  tax  is  based,  not  on  the 
amount  of  net  income,  but  on  the  percentage  such  net 
income  is  of  the  invested  capital. 

This  method  of  computing  the  tax  is  applicable  only 
where  the  trade  or  business  has  invested  capital.  Where 
there  is  no  invested  capital,  or  only  a  nominal  invested 


EXCESS   PROFITS    TAX  653 

capital,  including,  in  the  case  of  an  individual,  salaries, 
wages,  fees,  or  other  compensations,  a  flat  tax  of  8  per 
cent  is  levied  on  the  taxable  net  income  in  excess  of  the 
specific  deduction  (see  page  644). 

NET  INCOME  FOR  PRE-WAR  PERIOD 

Definition— "Taxable  year"  and  "Pre-war  period." — The 
term  "taxable  year"  is  clearly  defined  in  the  law.  For 
individuals,  partnerships  and  corporations  it  means  the 
calendar  year,  excepting  in  the  case  of  partnerships  and 
corporations  which  have  a  fiscal  year  which  does  not 
coincide  with  the  calendar  year,  in  which  case  the  tax- 
able year  means  the  fiscal  year.  The  first  taxable  year 
is  the  year  ending  December  31,  1917,  except  in  the 
case  of  a  corporation  or  partnership  which  has  its 
own  fiscal  year,  in  which  case  it  will  be  the  fiscal  year 
ending  during  the  calendar  year  1917.  If  a  corpora- 
tion or  partnership,  prior  to  March  1,  1918,  makes  a 
return  covering  its  own  fiscal  year,  and  includes  therein 
income  received  during  that  part  of  the  fiscal  year  fall- 
ing within  the  calendar  year  1916,  the  tax  for  the  tax- 
able year  will  be  "that  proportion  of  the  tax  computed 
upon  the  net  income  during  such  full  fiscal  year  which 
the  time  from  January  1,  1917,  to  the  end  of  such  fiscal 
year  bears  to  the  full  fiscal  year." 

In  order  to  determine  whether  a  person  or  corpora- 
tion may  deduct  from  his  income  seven  or  nine  per  cent 
(or  any  percentage  between  them)  of  his  capital,  it  is 
necessary,  as  we  have  seen,  to  ascertain  the  rate  of 
profits  made  by  such  person  or  corporation  during  the 
pre-war  period.  The  law  describes  the  pre-war  period 
as  the  calendar  years  1911-1913  inclusive.  But  if  a 
corporation  or  partnership  was  not  in  existence  or  a 
person  was  not  engaged  in  a  trade  or  business  during 
the  whole  of  such  period,  then  as  many  of  such  years 
during  the  whole  of  which  the  corporation  or  partner- 
ship was  in  existence  or  the  individual  was  engaged  in 


654  INCOME   AND   FEDERAL    TAX   REPORTS 

trade  or  business  will  be  taken  to  constitute  the  pre- 
war period.  What  is  to  be  done  with  corporations,  part- 
nerships and  individuals  that  do  not  come  even  under 
this  second  rule  is  explained  later. 

No  report  of  net  income  for  pre-war  period  required  in 
certain  cases. — No  report  of  the  net  income  for  the  pre- 
war period  will  be  required  of  either  individual,  part- 
nership or  corporation  in  the  following  cases: 

(1)  If  the  taxpayer  is  willing  to  accept  the  minimum 
percentage,  i.e.,  7  per  cent,  as  the  percentage  to  be  used 
in  computing  the  deduction  under  section  203  of  the 
law.  Therefore,  if  the  taxpayer's  pre-war  rate  of  in- 
come on  his  pre-war  "invested  capital"  was  7  per  cent 
or  less,  he  will  not  make  a  report  of  pre-war  income 
and  pre-war  "invested  capital." 

(2)  If  the  trade  or  business  has  no  invested  capital, 
or  not  more  than  a  nominal  invested  capital,  and  is 
taxable  only  at  the  8  per  cent  rate  under  section  209  of 
the  law. 

In  either  of  the  above  cases,  however,  a  return  of 
information  as  to  all  facts  which  may  be  necessary  for 
the  ascertainment  of  the  capital  and  income  for  the 
taxable  year  will  be  required,  except  in  the  case  of 
those  who  are  exempt  from  the  tax. 

Net  income  of  citizens  or  residents  for  pre-war  period. — 
The  intention  of  the  law  is  to  tax  the  excess  profits 
(of  businesses  having  more  than  a  nominal  invested 
capital)  of  the  present  taxable  year  as  compared  with 
the  profits  of  the  pre-war  period.  It  is  therefore  nec- 
essary to  calculate  the  pre-war  profits  on  the  same 
basis  as  the  taxable  year  profits  (see  pp.  644,  686).  If, 
therefore,  in  computing  the  net  income  for  the  taxable 
year  an  individual  deducts  a  reasonable  amount  desig- 
nated as  salary  (p.  659),  he  must  also,  in  computing  net 
income  for  the  pre-war  period,  make  a  corresponding 
deduction  (Reg.  41,  Art.  40). 


EXCESS   PROFITS    TAX  655 

Net  income  of  individuals  for  the  pre-war  period  when 
they  were  not  engaged  in  trade  or  business,  and  in  other 
exceptional  cases. — (1)  Where  the  citizen  or  resident  was 
not  engaged  in  a  trade  or  business  during  the  pre-war 
period. — Where  the  individual  was  not  in  trade  or  busi- 
ness during  the  pre-war  period  (as  that  period  is  de- 
fined above)  the  law  in  effect  assumes  that  during  such 
period  the  individual's  net  income  was  8  per  cent  of  his 
invested  capital  (section  204). 

(2)  (a)  Where  the  citizen's  or  resident's  income  for 
the  pre-war  period  cannot  be  satisfactorily  determined, 
or  (b)  where  pre-war  profits  were  lower  by  one  per 
cent  or  more  of  the  net  income  to  the  invested  capital 
of  representative  concerns  engaged  in  a  similar  trade  or 
business  during  the  same  period,  or  (c)  where  he  made 
no  profits  though  he  was  engaged  in  business. — If  the 
Secretary  of  the  Treasury,  upon  complaint,  finds  that 
any  of  the  conditions  mentioned  in  the  heading  of  this 
paragraph  exists  then  the  pre-war  rate  of  profits  is  to 
be  taken  as  being  the  same  as  that  of  representative 
concerns  in  the  same  line  of  business,  not,  however,  less 
than  7  per  cent  or  more  than  9  per  cent. 

Whether  an  individual's  rate  of  profits  was  subnor- 
mal or  not,  is  to  be  ascertained  by  comparing  it  with 
the  rate  of  profits  of  representative  concerns.  This 
means,  of  course,  that  sooner  or  later  the  Treasury  De- 
partment will  have  to  determine  the  average  pre-war 
rate  of  profits  in  various  lines  of  business.  As  this  will 
not  be  done  till  after  the  returns  are  due,  in  cases  aris- 
ing under  subdivisions  (a)  or  (c),  the  return  will  be 
filed  and  the  tax  assessed  in  the  first  instance,  assuming 
a  7  per  cent  pre-war  rate  of  profit;  and  in  cases  aris- 
ing under  (b)  the  return  will  be  filed  and  the  tax  as- 
sessed in  the  first  instance  on  the  basis  of  the  actual 
subnormal  pre-war  rate  of  profits,  but  not  less  than  7 
per  cent.  In  any  of  these  cases  the  taxpayer  should 
file  with  his  return  a  claim  for  abatement  (Form  47)  of 


656  INCOME   AND   FEDERAL    TAX   REPORTS 

the  amount  of  tax  by  which  the  tax  so  assessed  exceeds 
a  tax  computed  on  the  basis  of  the  pre-war  rate  of 
profits  of  representative  concerns  (Law,  Section  205, 
[&]).    See  also  p.  698,  Claims  for  abatement. 

Perhaps  an  illustration  will  make  this  clear.  An  in- 
dividual was  in  business  in  1911-1913  but  made  no 
profits.  He  had  continuously  invested  in  his  business 
$100,000  of  capital.  His  income  for  1917  was  $25,000. 
He  would  have  to  pay  the  excess  profits  tax  on  $25,000 
less  $7,000  (the  minimum  deduction  being  7  per  cent 
of  the  invested  capital)  and  less  the  specific  exemp- 
tion of  $6,000.  If,  however,  representative  concerns 
in  the  same  line  of  business  had  made  8  per  cent  dur- 
ing the  pre-war  period,  by  "complaining"  and  filing  his 
claim  for  abatement  along  with  his  return,  he  would 
eventually,  when  the  claim  was  adjusted,  pay  a  tax  on 
$25,000  less  8  per  cent  and  less  the  specific  exemption 
of  $6,000.  That  is,  he  would  pay  a  tax  on  $25,000  less 
$8,000,  less  the  specific  exemption  of  $6,000.  If  his 
capital  had  been  only  $50,000,  his  taxable  net  income 
would  be  $25,000  less  $4,000  (i.e.,  8  per  cent  of  $50,000) 
less  the  specific  exemption  of  $6,000. 

Net  income  for  pre-war  period  of  non-resident  aliens. — 
The  pre-war  rate  of  profits  of  non-resident  aliens  is 
worked  out  on  the  basis  of  income  from  sources  within 
the  United  States  only,  and  is  found  for  non-resident 
aliens,  as  it  is  for  citizens  or  residents.  However,  non- 
resident aliens  are  not  entitled  to  the  rule  pertaining  to 
businesses  having  no  net  income,  although  in  existence 
during  the  pre-war  period  (Case  2  (c),  p.  655),  but  they 
are  entitled  to  the  application  of  the  rule  for  finding  a 
standard  of  pre-war  profits,  in  cases  (a)  and  (b),  men- 
tioned on  p.  655,  and  where  they  are  not  engaged  in 
business  or  trade  during  the  pre-war  period  (section 
204).  In  any  event,  they  may  take  at  least  7  per  cent 
instead  of  the  actual  pre-war  rate  of  income.  (Section 
203,  subdivision  [c].) 


EXCESS   PROFITS    TAX  657 

Pre-war  profits  of  partnerships. — The  net  income  of  a 
partnership  for  each  of  the  years  1911,  1912  and  1913 
is  determined  in  the  same  manner  as  the  net  income 
for  the  taxable  year.  Dividends  from  stock  or  from  the 
net  earnings  of  corporations,  joint-stock  companies,  or 
associations,  or  insurance  companies,  subject  to  the  tax 
imposed  by  the  laws  of  1909  or  1913  are  to  be  deducted. 
Moreover,  if  salaries  of  partners  (p.  660)  and  interest 
(p.  661)  are  deducted  in  the  taxable  year,  a  correspond- 
ing deduction  must  also  be  made  from  net  income  of  the 
years  1911,  1912,  and  1913.  (Reg.  41,  Art.  34).  The 
other  rules  for  finding  the  pre-war  profits  of  domestic 
partnerships  are  the  same  as  those  applying  to  resi- 
dents and  citizens,  while  those  for  foreign  partnerships 
are  the  same  as  those  for  non-resident  aliens. 

Pre-war  profits  of  domestic  corporations. — To  find  the 
profits  for  1911,  the  corporation  simply  refers  to  its 
report  covering  the  income  for  that  year  under  the 
law  of  1909,  and  adds  the  tax  paid  under  that  law  in 
1911  on  income  earned  in  1910,  as  this  income  tax  was 
subtracted  in  the  report  filed  in  1911  in  arriving  at  net 
income.  The  same  process  is  repeated  in  finding  the 
profits  for  1912.  To  find  the  net  income  for  1913,  add 
to  the  net  income  as  shown  in  the  return  filed  in  that 
year  the  income  tax  paid  within  the  calendar  year  1913 
and  deduct  from  the  total  so  obtained  the  dividends  re- 
ceived from  corporations,  etc.,  subject  to  that  tax.  (Reg. 
41,  Art.  29.)  (The  law  of  1909  provided  that  such  divi- 
dends should  be  deducted,  and  hence  that  matter  was 
taken  care  of  in  the  reports  filed  in  pursuance  of  that 
law.) 

Pre-war  profits  of  domestic  corporations  not  in  existence 
before  the  war. — The  same  rule  applies  here  as  applies 
to  citizens  and  residents:  the  pre-war  profits  are  as- 
sumed, for  the  purpose  of  the  law,  to  be  8  per  cent  of 
the  capital  in  the  taxable  year. 


658  INCOME    AND    FEDERAL    TAX    REPORTS 

Pre-war  profits  of  domestic  corporations,  where  such 
profits  cannot  be  satisfactorily  determined,  or  where  sub- 
normal or  where  the  corporation,  though  in  existence,  made 
no  profits. — "What  was  said  on  this  subject  with  respect 
to  citizens  and  residents  applies  to  domestic  corpora- 
tions as  well.    (See  page  655.) 

Pre-war  profits  of  foreign  corporations. — The  pre-war 
profits  of  foreign  corporations  are  found  in  the  same 
way  as  are  those  of  domestic  corporations,  except  that 
the  examination  of  the  income  is  restricted  to  that  com- 
ing from  sources  within  the  United  States.  As  in  the 
case  of  individuals  and  partnerships,  foreign  corpora- 
tions come  under  the  rule  applicable  to  domestic  con- 
cerns in  cases  where  such  foreign  corporations  were 
not  in  existence  during  the  pre-war  period,  and  to  the 
rules  applicable  to  cases  (a)  and  (b)  on  p.  655,  but  they 
are  not  entitled  to  the  rule  pertaining  to  claims  for 
abatement  of  tax  where  the  corporation  was  in  existence 
in  the  pre-war  period  but  made  no  profits.  In  any  case 
they  may,  however,  take  7  per  cent  instead  of  the  actual 
pre-war  rate  of  income,  if  that  is  lower. 

Pre-war  capital. — The  capital  of  the  concern  during 
the  pre-war  period  to  which  the  profits  are  to  be  ap- 
plied in  order  to  discover  the  pre-war  rate  of  profits  is 
calculated  for  that  period  in  the  same  way  that  capital 
is  calculated  for  the  taxable  year.  (See  the  discussion 
in  the  following  pages.) 

NET  INCOME  DURING  THE  TAXABLE  YEAR 

Net  income  of  individuals. — The  net  income  of  an  indi- 
vidual employing  no  invested  capital  or  only  nominal 
capital  in  his  trade  or  business  is  determined  by  select- 
ing from  the  income  tax  return  for  the  year  those  items 
mentioned  on  p.  644  under  "Income  subject  to  tax." 

When  there  is  invested  capital  employed  in  the  trade 
or  business,  the  same  method  is  followed,  except  that 
from  such  income  there  may  be  deducted  a  reasonable 


EXCESS   PROFITS    TAX  659 

salary.  (See  next  paragraph.)  Moreover,  dividends  re- 
ceived from  corporations,  joint-stock  companies  or  asso- 
ciations, which  are  subject  to  the  income  tax  are  not 
subject  to  this  Excess  Profits  tax.  An  individual  dealing 
in  securities,  however,  must  include  (1)  the  amount  of 
interest  received  on  bonds  or  obligations  of  the  United 
States,  issued  after  September  24,  1917,  in  excess  of 
$5,000  principal  of  such  bonds  or  obligations,  and  (2) 
the  proportion  of  dividends  received  upon  the  stock  of 
foreign  corporations  which  the  net  income  of  such  cor- 
porations from  sources  outside  the  United  States  is  of 
their  entire  net  income.     (Reg.  41,  Art.  36.) 

Contributions  to  religious  and  charitable  organizations, 
etc.  (see  page  113),  subject  to  the  limitations  there  men- 
tioned, may  be  deducted  in  computing  the  net  income  of 
the  trade  or  business  for  the  purpose  of  the  Excess 
Profits  tax,  providing  it  is  shown  to  the  satisfaction  of 
the  Commissioner  of  Internal  Revenue  that  such  con- 
tributions are  made  by  the  trade  or  business  and  not  by 
the  individual  in  his  personal  capacity.  (Reg.  41,  Art. 
37.) 

Deduction  of  salary  by  individual  employing  invested  cap- 
ital.— An  individual  carrying  on  a  trade  or  business  hav- 
ing an  invested  capital  may,  for  the  purpose  of  the  Ex- 
cess Profits  tax,  designate  a  reasonable  amount  as  salary 
for  services  actually  rendered  by  him  in  the  conduct  of 
his  trade  or  business,  and  he  may  deduct  such  salary 
from  the  net  income  of  the  trade  or  business,  thus 
making  the  excess  profits  for  the  trade  or  business 
smaller.  But  any  such  salary  is  subject  to  the  Excess 
Profits  tax,  if  any  (i.e.,  if  this  salary  and  other  sal- 
aries received  by  the  individual  amount  to  more  than 
$6,000),  at  the  8  per  cent  rate  under  Section  209 
(Form  1040).  The  balance  of  the  income  in  excess 
of  the  allowed  deductions  derived  from  the  trade  or 
business  is  subject  to  the  graduated  rates  prescribed 
in  Section  201   (Form  1103).     The  Treasury  Depart- 


660  INCOME   AND   FEDERAL    TAX   REPORTS 

ment  has  ruled  (T.  D.  2611)  that  "in  no  case  shall  the 
amount  of  such  salary  so  designated  be  in  excess  of  the 
salaries  or  compensation  customarily  paid  for  similar 
services  under  like  responsibilities  by  corporations  or 
partnerships  engaged  in  like  or  similar  trades  or  busi- 
nesses. In  the  case  of  a  non-resident  alien  individual, 
the  amount  shall  be  limited  to  that  portion  of  the  sal- 
ary or  compensation  which  is  for  service  rendered  with 
respect  to  trade  or  business  carried  on  in  the  United 
States." 

It  will  appear,  therefore,  that  where  an  individual 
conducts  a  business  with  "invested  capital"  he  should, 
for  Excess  Profits  tax  purposes,  deduct  a  salary  in  the 
following  case:  Where  the  net  income  during  the  tax- 
able year  exceeds  the  deduction  (see  page  691)  plus  the 
specific  exemption  (see  page  690).  The  amount  of  sal- 
ary to  be  deducted  will  depend  on  the  relative  size  of 
the  individual's  salary  and  the  business'  excess  profits, 
taking  into  consideration  the  higher  rates  imposed  on 
the  latter  profits.  (The  graduated  taxes  on  businesses 
with  invested  capital  are  higher  than  the  tax  on  salaries 
at  the  flat  8  per  cent  rate.) 

Where  a  person  derives  income  from  his  interest  in 
a  partnership,  such  income  in  his  hands  will  not  be 
subject  to  the  Excess  Profits  tax.  This  income  is 
treated  as  income  from  dividends  received  from  a  cor- 
poration. Such  share  of  the  profits  (like  dividends 
of  a  corporation),  distributed  or  distributable  to  the  in- 
dividual partner,  is  not  deductible  by  the  partnership 
in  determining  its  net  income  for  Excess  Profits  tax 
purposes.  But  where  the  partnership  deducts  as  an 
expense  (for  the  purpose  of  the  Excess  Profits  tax) 
reasonable  salaries  paid  to  the  individual  partners  for 
services  actually  rendered  during  the  taxable  year,1  the 
individual  partner's  salary  (including  any  amount  al- 
lowed to  the  partnership  as  a  deduction  on  his  account 

i  See  page  661,  post. 


EXCESS   PROFITS   TAX  661 

for  the  period  prior  to  March  1,  1918)  is  subject,  in 
the  hands  of  the  recipient,  to  the  Excess  Profits  tax,  if 
any,  at  the  8  per  cent  rate  under  Section  209.  (T.  D. 
2612.) 

Net  income  of  partnerships  for  the  taxable  year. — The 
net  income  of  partnerships  is  figured  in  the  same  way 
as  that  of  individuals  (salaries  paid  to  partners  and 
interest  paid  on  loans  by  partners  may  be  deducted), 
foreign  partnerships  for  this  purpose  being  treated  as 
non-resident  aliens,  and  domestic  partnerships  as  citi- 
zens or  residents. 

In  determining  the  net  income  of  the  partnership,  the 
interest  on  bonds,  etc.,  of  the  United  States  issued  after 
September  24,  1917,  in  excess  of  the  interest  on  $5,000 
of  such  bonds,  is  to  be  included  as  income;  and  divi- 
dends received  from  corporations,  etc.,  subject  to  the 
income  tax  may  be  deducted.  (Reg.  41,  Art.  30.)  But 
only  that  proportion  of  the  dividends  received  on  stock 
of  foreign  corporations  may  be  deducted  as  the  net  in- 
come of  such  foreign  corporation  from  sources  within 
the  United  States  is  of  its  entire  net  income.  (Reg.  41, 
Art.  27.) 

In  computing  net  income  for  the  purpose  of  the  Ex- 
cess Profits  tax,  a  partnership  will  be  allowed  to  de- 
duct as  an  expense  reasonable  salaries  or  compensation 
paid  to  individual  partners  for  personal  services  actu- 
ally rendered  during  the  taxable  year,  if  the  payments 
are  made  in  accordance  with  prior  agreements  and  are 
properly  recorded  on  the  books  of  the  partnership.  In 
no  case  may  the  salaries  or  compensation  so  deducted 
be  in  excess  of  the  salaries  or  compensation  custom- 
arily paid  for  similar  services  under  like  responsibili- 
ties by  corporations  engaged  in  like  or  similar  trades 
or  businesses. 

With  respect  to  any  period  prior  to  March  1,  1918, 
where  no  previous  agreement  has  been  made  as  to 
salaries  or  compensation,  a  similar  deduction  will  be 
allowed  for  services  actually  rendered. 


662  INCOME   AND    FEDERAL    TAX   REPORTS 

In  the  case  of  a  foreign  partnership  the  deduction 
will  be  limited  to  those  portions  of  salaries  or  com- 
pensation which  are  paid  for  services  rendered  with 
respect  to  trade  or  business  carried  on  in  the  United 
States.     (T.  D.  2611.) 

A  partnership  with  "invested  capital"  should,  there- 
fore, for  the  purpose  of  the  Excess  Profits  tax,  deduct 
and  pay  salaries  (instead  of  a  share  of  the  profits)  to 
partners  in  the  following  case:  when  the  net  income  of 
the  partnership  in  the  taxable  year  exceeds  the  deduc- 
tion (see  page  691)  and  the  specific  exemption  (see  page 
690).  The  amount  of  salary  paid  (instead  of  a  share 
in  the  profits)  will  depend  upon  the  relative  size  of  the 
salary  of  each  partner  and  of  the  excess  profits  of  the 
partnership,  it  being  remembered  that  the  graduated 
rates  of  tax  on  excess  profits  are  considerably  more 
than  the  flat  8  per  cent  rate  imposed  on  salaries  in 
excess  of  $6,000. 

A  partnership  may  also  deduct  interest  paid  to  an 
individual  partner  on  any  bona-fide  loan,  but  no  deduc- 
tion for  so-called  interest  on  capital  will  be  allowed. 
(Eeg.  41,  Art.  33.) 

Net  income  of  domestic  corporations  for  the  taxable  year. 
— The  net  income  of  domestic  corporations  for  the  tax- 
able year  is  found  in  the  same  way  as  that  used  for 
income  tax  purposes,  adding  to  that  income  the  amount, 
if  any,  received  as  interest  on  bonds  or  other  obligations 
of  the  United  States,  issued  after  September  1,  1917, 
in  excess  of  the  interest  on  $5,000  principal  of  such 
bonds  or  obligations,  and  deducting  from  the  total  the 
dividends  received  from  corporations,  etc.,  subject  to 
the  income  tax.  The  rule  as  to  the  deduction  of  divi- 
dends on  foreign  corporations  is  the  same  as  that  found 
on  p.  661. 

Net  income  of  foreign  corporations  for  the  taxable  year. 
— Foreign  corporations  figure  their  net  income  for  the 
taxable  year  in  the  same  way  that  domestic  corporations 


EXCESS   PROFITS    TAX  663 

do,  except  that  they  confine  themselves  to  income  de- 
rived from  sources  within  the  United  States. 

COMPUTATION  OF  INVESTED   CAPITAL 

When  invested  capital  must  be  computed. — Where  a  con- 
cern must  make  a  return  and  it  does  not  come  under 
the  class  whose  capital  is  nominal,  it  becomes  neces- 
sary for  it  to  compute  its  invested  capital.1  It  must  be 
remembered  that  its  invested  capital  consists  of  its 
assets,  which  are  listed  on  the  assets  side  of  its  balance 
sheet,  and  which  may  be  classified  as  follows:  (a)  cash; 
(b)  tangible  property;  (c)  patents  and  copyrights;  (d) 
good- will,  trade-marks,  trade  brands  and  other  intangible 
property. 

Tangible  and  intangible  property. — Of  the  kinds  of  as- 
sets mentioned  in  the  foregoing  paragraph,  cash  and 
patents  and  copyrights  are  self-explanatory.  A  word 
about  the  difference  between  tangible  and  intangible 
property  may  not  be  out  of  place.  Intangible  property 
is  specifically  defined  in  the  law  and  regulations  as 
"property  of  a  character  similar  to  good-will,  trade- 
marks and  trade  brands."  (In  the  regulations  and  in 
this  book  the  term  "intangible  property"  does  not  in- 
clude patents  or  copyrights.)  Possibly  other  forms  are 
"the  going-concern  value"  of  public  utilities,  organiza- 
tion expenses  and  the  like ;  but  as  to  these,  whether  they 
are  to  be  considered  assets  at  all,  or  as  tangible  assets, 
the  Treasury  Department  says  it  will  make  rulings  as 
occasion  may  demand.  The  following  classes  of  prop- 
erty, when  paid  in  for  stock  or  shares  in  a  corporation 
or  partnership,  will  be  regarded  as  tangible  property 
so  paid  in:  stocks,  bonds,  bills  and  accounts  receiv- 
able, notes  and  leaseholds. 

Average  invested  capital. — The  amount  of  invested  cap- 
ital is  not  necessarily  constant  during  the  entire  pre- 

i  Even  corporations  claiming  to  have  nominal  capital  only,  or  claiming 
that  they  cannot  satisfactorily  determine  the  amount  of  their  invested 
capital,  must  fill  out  Form  1103  as  far  as  practicable  to  show  the  facts 
necessary  for  action  on  their  claim. 


664  INCOME   AND   FEDERAL    TAX   REPORTS 

war  or  taxable  year.  To  determine  the  invested  capital 
for  any  year,  the  law  requires  that  an  average  amount 
be  ascertained  on  a  monthly  basis.  The  amounts  of 
capital  invested  in  each  month  of  the  year  are  added 
together  and  the  total  divided  by  twelve.  If  a  change 
in  the  capital  investment  is  made  during  a  month,  the 
average  amount  for  that  month  may  be  ascertained  by 
multiplying  the  investment  as  of  the  first  day  by  the 
number  of  days  from  the  first  to  the  date  of  change, 
adding  to  that  amount  the  product  of  the  new  invested 
capital  times  the  number  of  days  remaining,  including 
the  date  of  change,  and  dividing  the  result  by  the  num- 
ber of  days  in  the  month. 

The  method  of  averaging-  invested  capital  prescribed  by 
Form  1103. — The  Eegulations  (Art.  43)  seem  to  provide 
the  method  of  averaging  the  capital  just  described;  it 
is  applied  in  the  solution  of  the  problem  on  page  685. 
The  form  of  return,  however,  requires  a  different  meth- 
od. Suppose  the  capital  at  the  beginning  of  the  year 
is  $2,970,000  (see  the  problem,  page  684)  and  that  it  is 
increased  on  September  15th  by  $500,000  and  decreased 
on  November  10th  by  $50,000.  Form  1103  requires 
each  change  to  be  averaged  over  the  year.  Thus  the 
increase  was  effective  for  16  days  in  September  and 
during  the  three  months  of  October,  November  and 
December,  or  in  all  3  16/30  months.  (If  September  had 
been  a  31-day  month  the  fraction  would  be  17/31.) 
$500,000  then  is  multiplied  by  316/31  and  divided  by 
12 — the  number  of  months  in  the  year.  The  result, 
$147,222  2/9  is  added  to  the  invested  capital  at  the 
beginning  of  the  year.  In  the  same  way  the  decrease 
of  $50,000  was  effective  121/30  months  and  the  aver- 
age decrease  for  the  year,  therefore,  was  $7,083 1/3. 
This  is  subtracted  from  the  invested  capital.  The  net 
result  of  the  two  changes  makes  the  invested  capital 
$3,110,138 — the  same  result  as  is  found  on  page  685. 


EXCESS   PROFITS   TAX  665 

Invested  capital  of  foreign  corporations  or  partnerships 
or  non-resident  alien  individuals. — In  the  case  of  foreign- 
ers, the  Kegnlations  provide  that  they  must  figure  out 
their  entire  invested  capital  and  then  for  the  purpose 
of  calculating  the  tax  take  that  proportion  which  their 
net  income  from  sources  within  the  United  States  is 
of  the  entire  net  income.  (Reg.  41,  Art.  48.)  Perhaps 
many  such  concerns,  however,  will  take  refuge  in  an- 
other regulation  which  says  that  Section  210  of  the 
law  relating  to  tax  on  concerns  whose  capital  cannot  be 
determined  will  apply. 

When  form  of  organization  has  been  changed. — The  in- 
tent of  the  law  is  undoubtedly  to  tax  a  business  as  such 
and  to  look  behind  the  formal  organization  in  which  it 
may  be  clothed.  If,  therefore,  a  business  after  Janu- 
ary 2,  1913,  is  substantially  the  same  business  as  it  was 
on  or  before  that  date,  though  it  may  change  the  form 
of  its  legal  organization  after  that  date,  the  net  income 
and  capital  of  the  predecessor  concern  prior  to  January 
2,  1913,  will  be  deemed  to  have  been  its  net  income  and 
invested  capital  for  the  pre-war  period. 

Changes  of  ownership  after  March  3,  1917. — The  law 
(Sec.  208)  makes  provision  for  a  special  case  that  may 
arise  where  a  trade  or  business  may,  after  March  3, 
1917,  change  ownership  by  consolidation,  reorganiza- 
tion or  otherwise,  though  at  least  a  one-half  control  of 
it  remains  in  the  control  of  the  same  person,  corpora- 
tion, association,  partnership,  or  any  of  them.  In  such 
special  cases  the  following  rules  will  apply  in  ascer- 
taining the  invested  capital  of  the  new  organization: 

1.  No  asset  transferred  or  received  from  the  prior 
trade  or  business  shall  be  allowed  a  greater  value  than 
would  have  been  allowed  in  computing  the  invested 
capital  of  such  prior  trade  or  business  if  such  asset  had 
not  been  so  received  or  transferred. 

2.  By  way  of  exception  to  the  above  rule,  if  the 
transferred  asset  was  paid  for  specifically  in  cash  or 


666  INCOME   AND    FEDERAL    TAX    REPORTS 

tangible  property,  the  value  of  the  asset  may  be  assumed 
to  be  the  actual  cash  or  cash  value  of  the  tangible  prop- 
erty paid  therefore  at  the  time  of  such  payment.  (The 
meaning  of  "tangible  property"  is  discussed  later.) 

INVESTED   CAPITAL  OF  PARTNERSHIPS  AND   CORPORATIONS 

How  invested  capital  of  a  corporation  or  partnership  is 
computed. — The  invested  capital,  as  we  saw,  consists  of 
the  concern's  assets  and  it  would  seem  that  in  the  last 
analysis  the  invested  capital  cannot  be  any  greater  than 
the  value  of  these. 

But  it  must  be  remembered  that  not  all  the  assets  a 
company  has  at  any  given  moment  of  time  can  be  called 
capital.  Funds  passing  in  and  out  are  not  capital. 
Besides  all  of  its  capital  is  not  "invested"  capital.  The 
word  "invested"  connotes  ownership.  Congress  intended 
in  effect  practically  to  make  "invested"  capital  and 
owned  capital  synonymous  terms.  The  question  then 
arises,  how  shall  we  measure  the  owned  capital  of  a 
concern?  The  law  and  regulations  say  that  we  are  to 
go  about  this  in  the  ordinary  way  that  any  business 
man  would  use.  We  simply  take  the  proprietorship — 
in  the  case  of  corporation  the  stock  plus  the  surplus, 
and  in  the  case  of  partnerships  the  stated  capital  plus 
the  surplus,  and  in  the  case  of  individuals  the  capital 
account — and  make  certain  adjustments  in  the  accounts 
representing  proprietorship  that  they  may  tell  the  true 
story  of  invested  capital,  as  invested  capital  is  denned 
by  the  law. 

We  begin  then  by  turning  to  the  liability  side  of  the 
concern's  balance  sheet — and  for  the  present  we  shall 
speak  of  corporations  and  partnerships  only. 

We  find  on  the  liability  side  of  the  balance  sheet 
four  classes  of  liabilities:  (a)  capital  stock  of  corpo- 
rations, or  nominal  capital  investment  in  a  partnership. 
These  will  be  spoken  of  hereafter,  respectively,  as 
stock  and  shares,  the  shares  being  the  amounts  stated 


EXCESS   PROFITS    TAX  667 

in  the  partnership's  balance  sheet  as  the  amounts  con- 
tributed by  the  partners. 

(b)  Funded  indebtedness,  the  same  being  the  long 
term  bond  issues  spoken  of  in  some  of  the  Eegulations 
as  "permanent  indebtedness." 

(c)  Short  term  or  current  liabilities. 

(d)  Surplus  and  undivided  profits — the  difference  be- 
tween the  assets  and  the  three  other  classes  of  liabilities. 

In  computing  invested  capital,  every  corporation  or 
partnership  shall  add  together  its  paid-in  capital  and 
its  paid-in  or  earned  surplus  and  undivided  profits.1 
This  is  the  basis  of  computation  of  the  invested  capital. 
To  find  the  true  invested  capital  intended  by  the  law, 
certain  adjustments  have  to  be  made,  and  these  can  be 
made  only  by  going  into  the  financial  history  of  the 
concern  and  finding  out  how  the  stock  was  issued  or 
the  circumstances  under  which  the  partners'  shares 
were  written  into  the  accounts,  and  how  the  surplus 
came  to  be  created.  The  procedure  to  be  followed  is 
to  find  out  what  assets  were  acquired  through  the  issue 
of  stock  and  then  to  adjust  the  amount  of  stock  and 
the  value  of  the  asset  to  each  other,  valuing  the  assets 
in  each  case  as  prescribed  by  the  Eegulations.  After 
all  the  stock  has  been  examined  the  surplus  account  is 
taken  up. 

Certain  adjustments  are  made  in  the  surplus  account 
as  provided  in  the  regulations  and  as  will  be  explained 
hereafter.  When  the  capital  account  and  the  surplus 
account  have  been  thus  adjusted,  their  sum  will  repre- 
sent the  invested  capital,  subject,  however,  to  one  pos- 
sible item  of  increase — a  percentage  of  the  funded 
indebtedness — and  to  one  possible  cause  for  reduction 

i  Reserves,  such  as  those  for  bad  debts,  for  insurance,  for  dividend 
equalization,  for  working  capital  and  for  pensions — in  fact,  all  except 
the  depreciation  reserves — consisting  of  amounts  not  deductible  in  the 
computation  of  net  income  under  the  Income  Tax  law,  msy,  if  properly 
explained,  be  included  as  part  of  the  surplus  for  the  purpose  of  com- 
puting invested  capital. 


668        IX CO  ME   AND   FEDERAL    TAX   REPORTS 

— where  the  sum  thus  ascertained  exceeds  the  sum  of 
the  admissible  assets  on  the  assets  side  of  the  balance 
sheet.  The  admissible  assets  are  all  the  assets  when 
valued  in  accordance  with  the  Regulations,  except  stocks, 
bonds  (other  than  bonds  of  the  United  States),  the  in- 
come from  which  is  not  subject  to  the  Excess  Profits 
Tax. 

We  are  now  ready  to  see  what  adjustments  must  be 
made  in  the  capital  and  surplus  accounts. 

Adjustment  of  capital  account  for  intangible  property 
acquired  on  or  subsequent  to  March  3,  1917. — If  in  looking 
through  our  capital  account  we  find  that  shares  were 
issued,  on  or  subsequent  to  March  3,  1917,  for  good- 
will, trade-marks  or  trade  brands,  the  item  must  be 
crossed  out  and  the  capital  account  reduced  by  that 
amount.  On  March  3,  1917,  the  first  Excess  Profits 
Tax  law  was  passed  and  it  would  have  been  to  the 
interest  of  concerns  to  capitalize  good-will  and  other 
intangible  property  by  issuing  stock  or  shares  therefor. 
To  prevent  such  wholesale  writing  up  of  the  capital 
account,  the  law  provides  that  intangible  property  can- 
not be  included  if  acquired  for  stock  or  shares  after 
March  3,  1917.  (Sec.  207.)  Notice  that  the  item  must 
be  crossed  out  in  either  case:  (a)  if  the  intangible 
property  was  acquired  on  or  subsequent  to  March  3, 
1917,  and  (b)  if  the  stock  or  shares  were  issued  on  or 
subsequent  to  March  3,  1917,  though  the  property  was 
acquired  prior  to  that  time. 

Adjustment  of  stock  or  shares  issued  for  intangible  prop- 
erty prior  to  March  3,  1917. — We  search  through  our 
capital  account  further  to  find  out  if  any  stock  or  shares 
were  issued  prior  to  March  3,  1917,  for  intangible 
property  acquired  prior  to  March  3,  1917.  If  we  find 
such  a  case  the  capital  account  will  have  to  be  adjusted 
as  follows: 

a.  Find  the  actual  value  of  the  intangible  property 
at  the  date  acquired. 


EXCESS   PROFITS    TAX  669 

b.  Find  the  par  value  of  the  stock  or  shares  issued 
in  payment  therefor. 

c.  Find  out  the  stock  or  shares  outstanding  on  March 
3,  1917,  and  figure  out  what  20  per  cent  of  it  would  be. 
(Where  stock  has  no  par  value,  we  give  them  the  mar- 
ket or  book  value  they  had  on  March  3,  1917.)  (Reg. 
41,  Art.  58.) 

Wherever  stock  has  been  issued  for  intangible  prop- 
erty in  excess  of  a,  the  amount  of  capital  should  be 
reduced  by  an  amount  equal  to  the  excess.  Thus,  if 
we  find  that  a  trade-mark  was  worth  $50,000  but 
$100,000  in  stock  was  issued  therefor,  the  stock  account 
is  written  down  to  $50,000  and  the  asset  which  was 
carried  at  $100,000  should  also  be  written  down  to  its 
actual  cash  value. 

After  separate  adjustments  have  been  made  in  this 
way  for  each  piece  of  intangible  property  acquired 
through  the  issue  of  stock  or  shares,  all  of  the  intan- 
gible property  thus  adjusted  is  added  up  and  the  sum 
is  reduced,  if  necessary,  to  the  20  per  cent  of  the  capital 
as  figured  out  in  c.  (Reg.  41,  Art  57-8.)  It  is  essential 
to  bear  in  mind  that  a,  b,  or  c  applies,  "whichever  is 
the  lowest." 

Adjustments  for  stock  or  shares  issued  for  patents  or 
copyrights. — We  next  ascertain,  in  searching  through  the 
capital  account  in  the  books  of  account,  if  at  any  time 
stock  or  shares  were  issued  for  patents  or  copyrights. 
If  so,  we  must  find  out  the  following  facts  about  the 
transactions : 

a.  What  was  their  actual  cash  value  at  the  time  they 
were  acquired. 

b.  What  was  the  par  value  of  the  stock  or  shares 
issued  for  them  at  the  time.  The  capital  account,  if 
necessary,  is  then  written  down  to  either  a  or  fe,  which- 
ever is  lower. 

Adjustment  of  stock  or  shares  issued  for  tangible  prop- 
erty acquired  prior  to  January  1,  1914. — We  then  go  over 


670  INCOME   AND   FEDERAL    TAX   REPORTS 

the  capital  account  again  to  see  if  any  stock  or  shares 
were  issued  for  tangible  property  prior  to  January  1, 
1914.    If  so,  we  establish  the  following  facts: 

a.  The  actual  cash  value  of  the  property  on  January 
1,  1914.  Probably  any  reasonable  appraisal  placed  on 
the  property  by  the  taxpayer  will  be  accepted  as  prima 
facie  evidence  of  its  value  on  that  date,  but  if  neces- 
sary the  taxpayer  may  be  required  to  sustain  his 
opinion  with  other  evidence,  such  as  the  appraisal  of 
some  disinterested  authority,  statement  of  assessed 
value  in  case  of  real  estate,  or  the  market  price  on 
January  1,  1914,  if  that  is  a  matter  of  general  public 
information.  Notice  that  the  original  value  at  the  time 
it  was  acquired  does  not  enter  into  the  discussion  at  all 
(if  the  property  was  acquired  prior  to  January  1,  1914). 

b.  The  par  value  of  the  stock  or  shares  issued  for 
the  property.  The  capital  account  is  thus  adjusted,  if 
necessary,  down  to  a  or  b,  whichever  is  lower.1 

Adjustment  of  stock  or  shares  issued  for  tangible  prop- 
erty on  or  after  January  1,  1914. — If  stock  or  shares  were 
issued  for  tangible  property  on  or  after  January  1, 
1914,  the  capital  account  must  be  adjusted  to  the  actual 
cash  value  at  the  time  of  payment.     (Reg.  41,  Art.  55.) 

Adjustments  for  issue  of  stock  or  shares  for  mixed  tan- 
gible and  intangible  property. — Where  it  has  been  dis- 
covered that  stock  or  shares  were  issued  for  a  lump 
amount  of  property,  part  of  which  was  tangible  and 
part  intangible,  some  difficulty  would  be  experienced  in 
applying  the  foregoing  rules  relating  to  adjustments. 
In  such  cases  some  attempt  must  be  made  to  separate 
the  property  and  apportion  the  stock  or  shares  issued 
to  each  class  of  property.  If  this  is  done  adjustments 
can  be  made  in  accordance  with  the  rules  already  given. 

i  In  filling  out  Form  1103  notice  that  the  instructions  on  the  blank 
referring  to  Schedule  c,  item  6,  contradict  the  law  and  the  Regulations 
(Art.  55).  Item  (b)  in  the  explanation  of  Schedule  c,  item  6,  should 
probably  read,  "amount  of  cash  paid  therefor,  or  if  purchased  before 
January  1,  1914,  value  on  that  date." 


EXCESS   PROFITS   TAX  671 

For  separating  the  property  into  different  classes 
the  following  rules  are  to  be  applied: 

(1)  In  the  absence  of  satisfactory  evidence  to  the 
contrary,  it  will  be  presumed,  in  the  case  of  a  corpo- 
ration, that  its  stock  was  issued  for  the  following  pur- 
poses in  the  order  named: 

(a)  Good-will  or  other  intangible  property, 

(b)  Patents  and  copyrights,  and 

(c)  Tangible  property. 

(2)  Upon  the  production  by  the  taxpayer  of  evidence 
satisfactory  to  the  Commissioner  of  Internal  Revenue 
as  to  the  actual  values  at  the  date  of  acquisition  of 
(a)  the  tangible  property  and  (b)  the  patents  and 
copyrights,  the  sum  of  these  two  items  may  be  applied 
against  the  total  par  value  of  the  securities  issued  and 
the  remainder  will  then  be  deemed  to  represent  the 
par  value  of  the  securities  issued  for  the  good-will  or 
other  intangible  property. 

It  may  be  that  so  much  mixed  property  was  acquired 
for  stocks  and  shares  that  the  whole  calculation  of 
invested  capital  is  thrown  out  on  account  of  the  in- 
ability of  the  Secretary  of  the  Treasury  to  determine 
satisfactorily  the  respective  values  of  the  several  classes 
of  property  at  the  time  of  payment.  In  such  cases  it 
may  be  necessary  to  abandon  the  attempt  to  fix  the 
amount  of  invested  capital  and  to  calculate  the  tax  as 
provided  by  the  law  for  cases  where  it  is  impossible 
to  calculate  the  invested  capital.  This  subject  is  dis- 
cussed at  length  later. 

Adjustments  where  stock  has  been  returned  to  the  cor- 
poration by  way  of  gift. — Frequently,  in  order  to  get 
around  the  State  laws  requiring  that  stock  must  not 
be  sold  at  less  than  par,  the  promoters  of  a  company 
will  issue  to  themselves  all  of  the  stock  of  the  com- 
pany for  a  mine,  or  for  good-will,  or  a  patent,  or  other 
property  of  uncertain  value.  A  value  will  be  placed 
on  the  property  equal  to  the  capital  stock  issued  and 


672  INCOME   AND   FEDERAL    TAX   REPORTS 

the  stock  will  be  called  full-paid.  In  order  to  get  cash, 
the  promoters  will  then  donate  a  large  part  of  their 
stock  back  to  the  corporation  and  since  this  has  been 
paid  for  in  full  it  may  be  issued  at  any  price.  It  may 
be  sold,  say,  for  $75  a  share,  although  the  par  value 
is  $100.  If,  in  searching  through  the  capital  account, 
such  a  situation  as  this  is  discovered,  the  original  trans- 
action as  far  as  the  donated  stock  is  concerned  will  be 
disregarded  and  the  stock  account  will  be  adjusted  in 
accordance  with  the  rules  above  given  just  as  though 
the  second  issue  had  been  'the  original  issue. 

Adjustment  of  surplus  account  for  tangible  property  paid 
in  for  stock  or  shares  substantially  below  their  par  value. — 
It  may  be  found  in  going  through  the  capital  account 
that  stock  was  issued,  say,  up  to  $100,000  for  tangible 
property  worth  $150,000.  If  the  transaction  was  en- 
tered on  the  books  by  debiting  the  property  account 
with  $150,000  and  crediting  the  stock  account  with 
$100,000  and  the  surplus  account  with  $50,000,  appar- 
ently no  further  adjustment  need  be  made.  But  the 
property  account  may  have  been  debited  only  with 
$100,000  and  the  surplus  account  credited  with  nothing. 
In  such  a  case  the  following  rule  would  apply:  Where 
it  can  be  shown  by  evidence  satisfactory  to  the  Com- 
missioner of  Internal  Eevenue  that  tangible  property 
has  been  conveyed  to  a  corporation  or  partnership  by 
gift  or  at  a  value  accurately  ascertainable  or  definitely 
known  as  at  the  date  of  conveyance,  clearly  and  sub- 
stantially in  excess  of  the  cash  or  the  par  value  of  the 
stock  or  shares  paid  therefor,  then  the  amount  of  the 
excess  will  be  classed  as  paid  in  surplus,  and  may  be 
added  to  the  surplus  account. 

Another  example  of  how  this  rule  works  may  be  help- 
ful. Suppose  a  company  is  offered  a  factory  site  and 
a  factory  building  if  it  will  locate  its  plant  in  a  certain 
town.  The  offer  is  accepted,  the  property  is  occupied, 
and  the  company  enters  the  transaction  on  its  books. 


EXCESS   PROFITS    TAX  673 

It  would  be  justified  in  adding  to  its  surplus  (and 
placing  "real  estate  and  plant"  on  its  asset  side  of  its 
balance  sheet)  an  amount  equal  to  the  ascertainable  or 
definitely  known  value  of  the  plant  or  real  estate  at 
the  time  it  was  acquired. 

What  is  meant  by  the  expression  "ascertainable  or 
definitely  known"  is  clearly  indicated  by  an  example 
given  in  the  Eegulations.  Suppose  a  concern  had  been 
given  a  plot  of  land  as  a  subsidy  to  enable  it  to  develop 
a  demand  for  its  services  by  colonization  of  the  donated 
land,  and  that  it  transpired  subsequently  that  the  land 
was  very  valuable  for  the  ores  it  contained.  If  the 
value  of  the  land  had  not  been  added  to  surplus  at  all, 
the  only  amount  that  now  could  be  added  would  be 
the  value  of  the  land  which  it  had  for  colonization 
purposes. 

How  can  it  be  established,  to  revert  to  the  example 
first  given  in  this  section,  that  the  property  which  at 
the  time  was  entered  on  the  books  at  $100,000  was 
really  worth  $150,000?  The  Regulations  say  as  to  this: 
"Evidence  tending  to  support  a  claim  for  a  paid-in 
surplus  under  these  circumstances  must  be  as  of  the 
date  of  conveyance,  and  may  consist,  among  other 
things,  of  (1)  an  appraisal  of  the  property  by  disin- 
terested authorities,  (2)  assessed  value  in  the  case  of 
real  estate,  and  (3)  the  market  price  in  excess  of  the 
par  value  of  the  stock  or  shares."    (Reg.  41,  Art.  63.) 

Adjustment  of  surplus  account — additions  for  tangible 
property. — The  concern  may  be  able  to  show  that  it  has 
really  been  using  capital  assets  that  have  never  ap- 
peared on  the  books  as  such.  For  example,  in  1910  it 
may  have  bought  100  typewriters  and  charged  them  to 
expense.  These  may  now  be  added  as  assets  and  an 
equivalent  amount  added  to  the  surplus,  subject,  how- 
ever, to  the  following  restrictions: 

1.  They  must  be  tangible  property. 


674        INCOME   AND    FEDERAL    TAX   REPORTS 

2.  They  must  have  a  life  extending  substantially  be- 
yond the  year  in  which  the  expenditure  was  made. 

3.  They  must  have  been  charged  as  current  expense. 

4.  They  must  still  be  owned  and  be  in  actual  use  by 
the  taxpayer  during  the  taxable  year. 

5.  They  must  have  been  acquired  prior  to  March  1, 
1913,  or 

6.  If  acquired  after  March  1,  1913,  they  cannot  be 
included  if  their  cost  was  included  in  the  Income  Tax 
return  for  the  year  in  which  they  were  acquired  as 
items  of  expense  deductible  from  gross  income  in  com- 
puting the  net  taxable  income. 

These  special  rules  are  applicable  to  special  tools, 
patterns  and  similar  assets: 

1.  Their  value  may  not  be  added  to  surplus  if  that 
value  "has  been  recorded  through  having  been  included 
in  the  price  of  goods." 

2.  If  their  cost  has  not  been  included  in  the  price  of 
goods,  and  they  are  held  for  only  occasional  use,  they 
shall  not  be  assigned  a  value  in  excess  of  the  fair  value 
based  upon  the  earnings  actually  arising  from  their 
current  use. 

3.  If  such  assets  are  not  used  currently  or  occasion- 
ally, they  may  be  included  only  at  scrap  value. 

Remember  that  none  of  these  adjustments  need  be 
made  if  the  assets  were  originally  charged  to  the  capi- 
tal account.  The  rules  apply  only  when  assets  have 
been  improperly  charged  to  the  expense  account.  Wher- 
ever an  adjustment  is  found  necessary,  the  burden  of 
establishing  the  fact  that  the  assets  were  charged  to 
expense  is  on  the  taxpayer  and  in  his  return  he  must 
make  a  statement  of  the  proposed  additions,  specifying 
the  kinds  and  amount  of  property  involved,  the  years 
in  which  the  expenditures  were  made,  and  the  method 
followed  in  distinguishing  between  capital  outlays  and 
current  expenses.     (Reg.  41,  Art.  64.) 


EXCESS   PROFITS   TAX  675 

Adjustments  not  allowed  for  good- will,  etc.,  acquired 
through  expense  items. — For  ten  years  a  concern  may 
have  spent  a  budget  of  $500,000  per  year  on  advertis- 
ing its  trade-marked  product.  The  trade-mark  thus 
acquired  would  probably  be  worth  thousands  of  dollars. 
If  all  or  a  part  of  the  amounts  expended  were  charged 
to  capital,  an  asset  good-will  or  trade-mark  being  placed 
on  the  asset  side,  say  with  a  value  at  $5,000,000  and 
an  equivalent  amount  were  added  to  surplus,  it  would 
seem  that  this  would  be  allowed  to  stand,  since  the 
Eegulations  made  no  specific  direction  for  the  reduc- 
tion of  surplus  even  though  the  asset  was  paid  for  in 
cash — not  specifically  spent  for  good-will,  but  indirectly 
for  good-will  by  buying  advertising  space.  It  must  be 
confessed  that  this  is  somewhat  contrary  to  a  strict 
reading  of  the  law,  but  is  in  accord  with  the  spirit  of 
the  Eegulations.  Perhaps  the  safe  method  would  be 
to  make  no  adjustment  in  a  case  of  this  kind,  but  to 
leave  the  matter  to  the  decisions  of  the  collector  in 
each  specific  case.  (See  later  the  discussion  on  ap- 
preciation.) 

Suppose,  however,  none  of  the  advertising  budget 
was  charged  to  capital,  but  was  all  charged  to  expense. 
In  such  a  case  the  concern  cannot  readjust  its  capital 
account  by  adding  good-will  to  assets  and  an  equivalent 
amount  to  surplus.  The  Eegulations  are  specific;  they 
insist  upon  a  literal  compliance  with  the  law.  The 
assets  cannot  be  added  unless  the  good-will  was  spe- 
cifically paid  for  as  such.  If,  for  example,  this  same 
good-will  was  sold  to  another  corporation  for  stock 
prior  to  March  3,  1917,  that  other  corporation  could 
include  the  asset  at  its  true  value  or  at  the  par  value 
of  the  stock  issued  for  it,  whichever  was  lower.  In  the 
hands  of  the  original  corporation  the  good-will  cannot 
be  included  in  the  invested  capital  by  being  written  into 
capital  account.  Where,  in  a  case  like  this,  a  concern 
through  ultra-conservative  accounting  has  kept   good- 


676  INCOME   AND   FEDERAL    TAX   REPORTS 

will  off  its  books,  it  may  apply  for  redress  under  Sec- 
tion 210  of  the  law.    (Reg.  41,  Art.  52.) 

Suppose,  now,  another  corporation  did  buy  this  good- 
will for,  say,  $1,000,000,  back  in  1900,  and  had  written 
it  off  $100,000  a  year  till  in  1910  it  had  disappeared  as 
an  asset.  The  company  could  reconstruct  its  surplus 
account,  as  far  as  this  item  is  concerned,  and  could  add 
$1,000,000  to  its  surplus  and  an  equivalent  amount  to 
its  asset  item,  good-will. 

Adjustments  in  accounts  of  concerns  that  have  gone 
through  some  form  of  reorganization. — Adjustments  can 
be  made  as  hereinbefore  provided,  using  the  books  of  a 
predecessor  concern  in  calculating  the  invested  capital 
for  the  pre-war  period  if  the  present  concern  is  a  re- 
organization of  the  predecessor,  which  took  the  place  of 
the  old  concern  after  January  2,  1913,  and  if  the  pres- 
ent business  is  substantially  a  continuation  of  the  old 
business.  Adjustments  of  the  invested  capital  for  the 
taxable  year  should  also  be  made  to  comply  with  Sec- 
tion 208  of  the  law  with  respect  to  reorganization,  etc., 
after  March  3,  1917.  Study  Sections  204  and  208  of 
the  law  and  the  Regulations,  Arts.  49-50. 

Adjustments  of  surplus  on  account  of  appreciation  taken 
up. — Another  adjustment  of  surplus  is  provided  for  by 
the  Regulations  for  appreciation  of  assets  that  has  been 
taken  up  on  the  books  with  a  consequent  increase  in 
surplus.  If  tangible  property  has  appreciated  and  the 
appreciation  has  been  written  up  on  the  books,  the 
amount  of  appreciation  subsequent  to  January  1,  1914, 
should  be  written  off,  unless  in  the  income  tax  return 
the  appreciation  was  included  as  taxable  income  for  the 
purpose  of  providing  a  new  value  for  the  asset  upon 
which  to  calculate  depreciation.  Appreciation  of  tan- 
gible assets  up  to  January  1,  1914,  is  not  to  be  written 
off  unless  the  depreciation  brings  the  asset  up  above 
the  par  value  of  the  stock  or  shares  for  which  it 
was   acquired,  and  in  such  a  case  it  should  be  writ- 


EXCESS   PROFITS    TAX  677 

ten  off  to  bring  the  asset  down  to  the  par  value  of 
the  stock. 

Appreciation  of  intangible  property  is  not  permitted 
by  the  Income  Tax  law,  and  since  under  the  Income  Tax 
law  good-will,  for  example,  cannot  be  appreciated  in 
such  a  way  as  to  make  the  appreciation  an  item  of  in- 
come subject  to  the  tax,  it  would  seem  that  any  appre- 
ciation of  intangible  assets  that  has  taken  place,  with  a 
consequent  inflation  of  the  surplus,  would  call  for  an 
adjustment  of  the  surplus  account  by  subtracting  from 
that  account  the  amount  of  appreciation. 

These  adjustments,  of  course,  can  only  be  made  after 
a  careful  study  of  the  various  capital  asset  accounts. 

Adjustments  in  the  surplus  account  by  reason  of  insuffi- 
cient allowance  for  depletion,  depreciation  and  obsolescence. 
— After  the  various  adjustments  described  above  have 
been  made,  another  careful  survey  of  the  assets  must  be 
made  to  see  if  any  of  them  are  listed  in  the  taxable 
year  at  some  original  value  or  adjusted  value  without 
taking  into  account  losses  or  expenses  sustained  from 
the  original  organization  of  the  business  concern  down 
to  the  taxable  year.  For  example,  if  stock  had  been 
issued  for  an  automobile  purchased  in  1913,  the  value  of 
the  automobile  at  the  time  it  was  acquired  having  been 
$3,000,  and  the  amount  of  stock  paid  therefor  $2,500, 
while  its  value  on  January  1,  1914,  had  fallen  to  $2,000, 
under  the  rules  stated  above  the  stock  account  of  $2,500 
would  have  to  be  reduced  to  $2,000 — the  value  of  the 
automobile  on  January  1,  1914.  Let  us  suppose,  now, 
that  through  a  period  of  four  years  the  asset  has  de- 
preciated $600  per  year.  Its  true  value  on  January  1, 
1917,  was  $600.  If  no  depreciation  had  been  charged 
against  this  asset  but  it  had  been  kept  on  the  books  at 
its  original  value  of  $3,000,  under  the  rule  explained 
above  the  capital  stock  would  have  been  reduced  from 
$2,500  to  $2,000;  now  the  surplus  account  would  be  re- 
duced by  an  amount  equal  to  the  difference  between 


678  INCOME   AND   FEDERAL    TAX   REPORTS 

$2,000,  the  value  of  the  automobile  on  January  1,  1914, 
and  $600,  the  value  of  the  automobile  at  the  beginning 
of  the  taxable  year.  Thus  the  surplus  would  be  reduced 
by  $1,400  and  the  asset  would  be  written  down  to  $600. 
Amounts  added  on  account  of  bonded  indebtedness. — 
After  all  the  calculations  have  been  made  as  above  de- 
scribed, the  amount  of  invested  capital  may  be  increased 
in  the  case  of  a  corporation  (not  of  a  partnership)  by 
a  certain  proportion  of  the  funded  indebtedness.1  This 
increase  in  the  invested  capital  is  not  permissible  un- 
der any  section  of  the  law,  but  is  permitted  by  the  Regu- 
lations (Art.  44),  almost,  if  not  quite,  contrary  to  the 
provision  of  the  law  (Section  207),  but  was  provided 
in  the  Regulations  to  bring  the  law  into  agreement  with 
the  provision  of  the  Income  Tax  law.  The  Regulation 
reads :  "A  corporation  which  under  the  Income  Tax  law 
is  allowed  to  deduct  only  a  part  of  the  entire  interest 
paid  upon  its  indebtedness,  may  include  in  its  invested 
capital  such  a  proportion  of  its  permanent  indebtedness 
as  the  amount  of  interest  upon  such  indebtedness  which 
the  corporation  is  not  allowed  to  deduct  is  of  the  total 
amount  of  interest  paid  upon  such  indebtedness  during 
the  taxable  year." 

Illustration:  a  corporation  has  $100,000  of  stock  and  $600,000  of 
bonds  bearing  5  per  cent  interest.  Under  the  Income  Tax  law  (Section 
1207)  this  company  could  deduct  from  its  gross  income  the  interest  at 
5  per  cent  on  its  capital  stock  plus  one-half  its  bonded  indebtedness,  ie., 
on  $400,000.  We  can  deduct  5  per  cent  on  $400,000  or  $20,000  out  of 
$30,000  of  interest  actually  paid.  Since  one-third  of  its  interest  is  not 
deductible  under  the  Income  Tax,  it  may  add  to  its  invested  capital  one- 
third  of  its  bonded  indebtedness  of  $600,000,  or  $200,000. 

Adjustments  to  be  made  in  the  assets  side  of  the  balance 
sheet. — We  have  gone  through  various  adjustments  in 
the  liability  side  of  the  balance  sheet.  Each  time  that 
an  adjustment  is  made  in  the  capital  account  or  in  the 

i  It  may,  however,  be  increased  in  the  case  of  a  limited  partnership, 
inasmuch  as  a  limited  partnership  is  subject  to  the  same  restriction  as 
to  the  amount  of  interest  deductible  as  a  corporation. 


EXCESS   PROFITS    TAX  679 

surplus  account,  an  equivalent  adjustment  must  be  made 
in  the  asset  account  to  which  the  capital  account  or  the 
surplus  account  corresponds. 

For  example,  if  a  patent  was  carried  on  the  books  at 
$100,000  because  that  amount  of  stock  (par  value)  had 
been  issued,  while  the  actual  cash  value  was  only  $50,- 
000,  the  capital  account  would  be  reduced  by  $50,000  and 
the  patent  account  by  $50,000. 

Final  adjustment  of  invested  capital  as  of  beginning  of 
year. — A. — We  have  now  (1)  a  sum  obtained  by  adding 
adjusted  capital,  adjusted  surplus,  and,  in  the  case  of  a 
corporation,  an  allowable  proportion  of  funded  indebt- 
edness. 

B. — On  the  assets  side,  we  have  adjusted  assets,  ad- 
justed as  described  in  the  preceding  paragraphs.  (2) 
These  are  added  up,  first  excluding  inadmissible  assets. 
The  inadmissible  assets  are  stocks  and  bonds  held  by 
the  concern  with  the  exception  of  United  States  bonds, 
and  such  assets  as  may  not  come  under  the  class  of 
either  (a)  cash,  (b)  tangible  property,  (c)  patents  or 
copyrights,  (d)  good- will,  trade-marks,  trade  brands, 
and  other  intangible  property.  Tax-free  securities  and 
stocks  in  foreign  corporations  may  be  included  as  ad- 
missible assets  to  the  extent  authorized  in  Articles  45 
and  46  of  Regulations  41,  which  provide:  "Whenever 
income  consists  partly  of  profits  arising  from  trading 
in  stocks,  bonds,  etc.,  the  dividends  or  interest  on 
which  are  not  subject  to  such  tax,  and  partly  of  such 
dividends  or  interest,  then,  subject  to  the  limitations 
as  to  borrowed  money,  there  shall  be  included  in  the 
invested  capital  an  amount  which  bears  the  same  ratio 
to  the  total  amount  invested  in  such  stocks  or  bonds 
as  the  amount  of  such  gains  or  profits  bears  to  the 
total  amount  of  such  income,"  and  "in  the  case  of 
domestic  corporations  or  partnerships  and  of  citizens 
or  residents  of  the  United  States  holding  stock  in  a 
foreign  corporation  part  of  whose  net  income  is  sub- 


680  INCOME    AND    FEDERAL    TAX    REPORTS 

ject  to  the  Income  Tax,  there  shall  be  included  in 
invested  capital  such  proportion  of  the  value  of  the 
stock  in  such  foreign  corporation  as  the  net  income  of 
such  foreign  corporation  from  sources  outside  the 
United  States  is  of  its  entire  net  income."  Fictitious 
items  like  Bond  Discount,  for  example,  would  have  to 
be  excluded  as  inadmissible  items,  since  it  does  not  come 
under  Class  (a),  (b),  (c)  or  (d).  There  would  also 
have  to  be  subtracted  an  amount  equal  to  all  current 
liabilities,  and  an  amount  equal  to  that  part  of  all 
funded  or  permanent  indebtedness,  the  interest  on 
which  is  permitted  to  be  deducted  from  income  in  ascer- 
taining net  income.  The  result  we  now  have  is  the  sum 
of  the  admissible  assets. 

C. — The  total  of  invested  capital,  as  shown  in  para- 
graph A,  is  now  compared  with  the  total  of  admissible 
assets,  as  shown  in  paragraph  B,  and  if  the  invested 
capital  thus  shown  is  larger  than  the  admissible  assets, 
the  invested  capital  must  be  reduced  to  the  total  of  the 
admissible  assets.  This  amount  is  the  invested  capital 
of  the  concern. 

Further  adjustments  for  changes  in  invested  capital  dur- 
ing the  taxable  year. — No  adjustment  need  be  made  of 
the  invested  capital  as  determined  in  the  preceding 
paragraphs  when  the  capital  stock  outstanding  has  not 
been  changed  during  the  year  nor  where  the  surplus 
account  has  been  neither  increased  nor  decreased.  In 
no  case  may  the  invested  capital  include  any  surplus  or 
undivided  profits  earned  during  the  taxable  year  ex- 
cept in  the  case  of  individuals,  see  page  686.  Where 
capital  stock  has  been  increased  during  the  taxable  year 
for  the  acquisition  of  assets  permitted  to  be  included  in 
invested  capital,  such  capital  stock  under  the  regula- 
tions heretofore  explained  may  be  added  to  the  invested 
capital,  but  the  amount  of  invested  capital  will  have  to 
be  averaged  over  the  year.  Where  the  surplus  has  been 
reduced  during  the  year,  the  same  rule  applies.    Ulus- 


EXCESS   PROFITS    TAX  681 

tration:  capital  stock,  $100,000;  surplus,  $50,000,  as  of 
January  1,  1917;  earnings  up  to  June  30,  1917,  $50,000; 
on  July  1,  1917,  a  cash  dividend  of  $50,000  was  declared 
as  being  paid  from  earnings  accrued  prior  to  January 
1,  1917;  the  invested  capital  in  this  case  would  be  as 
follows : 

$150,000  X  6  months  =    $900,000 
100,000  X  6  months  —      600,000 


12  )  $1,500,000  (  $125,000 

The  corporation  in  this  case  has  penalized  itself  by 
stating  that  dividends  were  paid  from  1916  earnings 
instead  of  1917  current  profits.  If  the  corporation  had 
declared  the  dividend  from  1917  profits  the  amount  of 
capital  invested  for  the  entire  year  1917  would  have 
been  $150,000,  instead  of  $125,000.  In  this  particular 
case,  the  stockholders  receiving  the  dividend  have  bene- 
fited at  the  expense  of  the  corporation,  since  the  former 
under  the  Income  Tax  are  taxed  only  at  the  super-tax 
rates  under  the  Income  Tax  law  that  was  in  effect  for 
the  year  1916  upon  such  dividends  paid. 

EXAMPLE  OF  COMPUTATION  OF  INVESTED  CAPITAL 
Balance  Sheet,  December  31,  1916 

(1)  Cash $100,000        Capital  Stock $3,000,000 

(2)  Real  estate,  plant  and  Bonds 1,000,000 

equipment 1,250,000        Accounts  payable 500,000 

(3)  Inventories 50,000        Reserves 100,000 

(4)  Accounts  receivable..         60,000        Surplus 2,050,000 

(5)  Liberty  bonds 40,000 

(6)  Stocks 1,000,000 

(7)  Patents    and    copy- 
rights   2,100,000 

(8)  Good-will,  etc 2,000,000 

(9)  Bond  discount 50,000 


Total $6,650,000  Total $6,650,000 


682  INCOME   AND    FEDERAL    TAX    REPORTS 

Capital  Stock  Adjustments 
IfTd-  Capital  Stock  issued;  aiSff         Asset  How 

merit  of  adjustment  £ck  »  affected 

I  $1,0000,000  issued  Jan.  15,  1915, 
for   trade-mark   actually   worth 

$800,000 $800,000  (8)  -$200,000 

II  $50,000  issued  for  a  patent  proved 

to  be  worthless 0  (7)  -     50,000 

III  $10,000  issued  for  plant,  then 
worth  $25,000,  acquired  January 
10,  1910.  Plant  worth  $20,000 
Jan.  1,  1914.  Adjusted  to  which- 
ever is  lower,  stock  issued  or  value 
on  Jan.  1,  1914.  The  difference 
is  treated  under  adjustment  of 

surplus 10,000  (2)  0 

IV  $400,000  issued  for  $400,000  in 
cash  Feb.  5, 1911;  no  adjustment 

necessary 400,000  (1)  0 

V  $500,000  issued  Sept.  13, 1906,  for 
a  plant  worth  at  that  time  $200,- 

000,  but  worth  $350,000  on  Jan. 

1,  1914.     Value  is  par  value  of 
stock  issued  or  cash  value  as  of 

Jan.  1,  1914 350,000  (2)  -150,000 

VI  $1,000,000  issued  for  a  patent  in 
1900.  $500,000  returned  as  a 
gift,  and  same  sold  for  $300,000. 
This  stock  received  must  be  en- 
tered at  only  $300,000 800,000  (7)  -200,000 

VII  $40,000  issued  July  1,  1913,  for 
Company  A's  entire  assets  includ- 
ing furniture  and  fixtures,  good- 
will, etc.  Company  offers  evi- 
dence to  show  tangible  assets 
were  worth  $25,000  on  Jan.  1, 
1914;  rest  will  be  deemed  intan- 
gible          40,000  ....  0 

$2,400,000 

VIII  Adjustment  for  intangibles  pur-  

chased  with  stock* 215,000  (8)  -$215,000 

Total  adjusted  stock $2,185,000 

The  stock  must  therefore  be  written  down  from  $3,000,000  to  $2,185,000, 
and  the  decrease  of  $815,000  corresponds  with  the  decrease  indicated  in  the 
assets  of  $815,000. 

*  Regulations  41,  Art.  58,  provide:  "The  20  per  cent,  limitation  upon  intangible  property 
purchased  prior  to  March  3,  1917,  for  or  with  stock  or  shares  of  the  corporation  or  partner- 
ship, applies  not  to  each  item  or  class  of  intangible  property  separately,  but  to  the  aggregate 
amount  of  all  such  property  so  purchased.  Such  intangible  property  may  be  included  in  the 
invested  capital  only  up  to  an  amount  not  exceeding  20  per  cent,  of  the  total  stock  or  shares 
of  the  corporation  or  partnership  on  March  3,  1917,  even  though  the  aggregate  amount  of 
such  intangible  property  be  greater  in  value  than  such  20  per  cent,  of  the  par  value  of  the 
total  stock  or  shares."  Here  we  assume  that  $815,000  was  issued  for  intangible  property 
(Adjustments  VI,  VII).  Since  20  per  cent,  of  the  stock  outstanding  on  March  3,  1917  ($3,- 
000,000)  is  $600,000  and  is  less  than  the  $815,000  of  intangible  property  paid  for  with  stock, 
the  adjustment  in  the  example  is  necessary,  the  $215,000  subtracted  being  the  difference 
between  the  $600,000  (20  per  cent,  of  capital  stock  outstanding  on  March  3, 1917)  and  $815,000, 
the  total  of  intangibles  bought  with  stock. 


EXCESS   PROFITS   TAX  683 

Surplus  Adjustments 

a  .    /.  Correspond-  jt 

Nature  of  adjustment  aJjZlent      ^Jj  affe°cZd 

IX  Jan.  10,  1910,  stock  of  $10,000 
issued  for  tangible  property  worth 
$25,000,  entered  on  books  at  $10,- 

000.  Value  of  property  on  Jan.  1, 
1914,  $20,000.  Since  tangible 
property  is  to  be  valued  as  of  Jan. 

1,  1914,  the  difference  between 
$10,000  and  the  value  on  Jan.  1, 

1914,  should  be  added  to  surplus.    +$10,000  (2)  +$10,000 

X  Sums  charged  to  expense  prior  to 
March  1,  1913,  for  furniture  and 
fixtures,  tools,  etc.,  still  in  exist- 
ence. Original  cost  $60,000,  less 
depreciation   of   $40,000   equals 

$20,000 +20,000  (2)  +20,000 

XI  Jan.  12,  1916,  good-will  was 
written  up  $35,000.  This  appre- 
ciation must  be  deducted -35,000  (8)  —35,000 

XII  On  July  1,  1917,  stock  held  by 
company  was  reappraised  and 
written  up  by  the  sum  of  $200,000. 
This  amount  of  appreciation  must 
be  written  off,  since  it  could  not 
be  entered  as  income  in  the  calcu- 
lation of  net  income -200,000  (6)  -200,000 

XIII  A  reserve  for  $100,000  was  set  up, 
but  upon  examination  it  is  found 
that  all  assets  are  carried  at  origi- 
nal value.  A  careful  examination 
shows  that  an  additional  deduc- 
tion of  $150,000  should  be  made 
to  bring  the  assets  to  their  true 
value.  This  calculation  is  made 
by  a  careful  consideration  of  the 

various  asset  accounts —150,000  (2)  —50,000 

(7)  -100,000 

XIV  Certain  of  the  accounts  receiv- 
able, amounting  to  $10,000,  are 

discovered  to  be  outlawed -10,000  (4)  -10,000 

XV  It  was  discovered  that  an  unin- 
sured building  was  destroyed  by 
fire  and  that  no  charge  was  made 
in  the  books  to  cover  the  loss. 
The  building  was  carried  on  the 

books  at  $50,000 -50,000  (2)  -50,000 

Net  change  in  surplus —$415,000 

Surplus  as  adjusted $1,635,000 


684 


INCOME   AND    FEDERAL    TAX   REPORTS 


Final  Adjustments 

Invested  capital  Adjusted  assets  and  items  of  adjust- 

Adjusted  capital  stock.  . .  $2,185,000        ment  affecting  the  asset 

Adjusted  surplus 1,635,000                                                  Adjustment 

Add    proportion    of    the  amounts 

bonded   indebtedness,   if                           (1)  Cash,  I $100,000 

necessary.        The  bonds                           (2)  Real  estate,  etc 1,030,000 

pay  5%.   Since  the  inter-  V,  IX,  X,  XIII,  XV. 

est  on  the  bonds,  $50,000,                           (3)  Inventories 50,000 

is  less  than  the  interest  on  (4)  Accounts  receivable, 

the  stock  plus  one-half                                 XIV 50,000 

the  bonded  indebtedness,                           (5)  Liberty  bonds 40,000 

no  part  of  the  bonded  in-                           (6)  Stocks,  XII 800,000 

debtedness  may  be  added  0        (7)  Patents,  VI,  XII. . . .  1,750,000 

(8)  Good-will,  II,  VIII, 

XI 1,550,000 

(9)  Bond  discount 50,000 

Total  invested  capital .  $3,820,000  Total $5,420,000 

Subtract : 

Stocks $800,000 

Bond  discount 
(fictitious)  50,000 

Amount  of  indebtedness,  including  all  cur- 
rent debts,  reserves  and  all  funded  debts 
except  that  added  in  other  column,  which 

in  this  case  happens  to  be  nothing 1,600,000 

2,450,000 


Admissible  assets  as  adjusted $2,970,000 

Since  the  invested  capital  as  calculated  in  the  left-hand  column  is  greater 
than  the  adjusted  admissible  assets,  the  invested  capital  will  have  to  be 
reduced  to  the  amount  of  the  adjusted  admissible  assets,  and  the  invested 
capital  of  this  concern,  therefore,  at  the  beginning  of  the  year,  will  be  $2,970,000. 
Certain  adjustments  may  have  to  be  made  for  changes  in  capital  during 
the  year.  Let  us  assume  that  on  June  1,  1917,  $250,000  additional  capital 
stock  was  issued  for  a  trade-mark,  on  Sept.  15,  1917,  $500,000  of  additional 
stock  was  issued  for  real  estate  reasonably  worth  that  much,  and  that  on 
Nov.  10,  a  dividend  of  $50,000  was  paid  and  that  this  dividend  was  stated 
to  be  paid  from  earnings  of  1916.  No  adjustment  is  necessary  for  surplus  or 
undivided  profits  earned  during  the  year  (Reg.  41,  Art.  47) .  Since  the  $250,000 
of  capital  stock  was  issued  for  intangible  property  after  March  3,  1917,  it 
may  be  disregarded  entirely.  The  $500,000  issued  for  real  estate  will  have 
to  be  added,  and  the  $50,000  taken  out  of  capital  surplus  instead  of  current 
earnings  will  have  to  be  subtracted.  The  company,  therefore,  had  $2,970,000 
of  invested  capital  up  to  Sept.  15.  From  that  date  to  Nov.  10,  it  had  invested 
capital  of  $3,470,000,  and  from  Nov.  10  to  the  end  of  the  year  its  invested 
capital  was  $3,420,000.    The  company,  therefore,  will  have  to  average  its 


EXCESS   PROFITS    TAX  685 

capital  monthly  over  the  year  as  follows,  and  will  have  to  attach  to  its  return 
a  balance  sheet  as  of  Jan.  1,  1917,  and  as  of  Dec.  31,  1917. 

January $2,970,000 

February 2,970,000 

March 2,970,000 

April 2,970,000 

May 2,970,000 

June 2,970,000 

July 2,970,000 

August 2,970,000 

September 3,236,667 

October 3,470,000 

November 3,435,000 

December 3,420,000 

12)$37,321,667 

$3,110,138  Invested  capital  for  the  year. 
Computation  for  September:      $2,970,000  x  14—  $41,580,000 

$3,470,000  x  16—  55,520,000 

30)  $97,100,000 

$3,236,667 

Computation  for  November:      $3,470,000  x  9—  $31,230,000 

$3,420,000  x  21—  71,820,000 

30)103,050,000 

$3,435,000 

INVESTED  CAPITAL  OF  INDIVIDUALS 

Items  to  be  included. — The  Treasury  Eegulations  pro- 
vide that  the  invested  capital  of  an  individual  shall  be 
measured  by  the  total  of  the  following  items: 

(a)  Actual  cash  paid  into  the  trade  or  business; 

(b)  Tangible  property  paid  into  the  trade  or  busi- 
ness; 

(c)  Intangible  property,  such  as  patents  and  copy- 
rights, and  good-will,  trade-marks,  trade  brands  and 
franchises.     (Eeg.  41,  Art.  66.) 

Valuation  of  tangible  property. — If  purchased  in  cash, 
tangible  property  must  be  valued  at  the  cost  at  the  time 
purchased.  If  the  cost  is  not  accurately  known,  it 
should  be  estimated.     (Eeg.  41,  Art.  67.) 

If,  however,  the  tangible  property  was  "paid  in  as 
such,"  i.e.,  was  received  by  the  individual  in  lieu  of  cash, 
prior  to  January  1,  1914,  the  property  must  be  valued 


686  INCOME   AND   FEDERAL    TAX   REPORTS 

at  its  actual  cash  value  ou  January  1,  1914.  "Adequate 
evidence  of  such  value  must  be  furnished  by  the  tax- 
payer." 

If  the  tangible  property  was  paid  in  on  or  after 
January  1,  1914,  the  actual  cash  value  at  the  time  of 
payment  will  govern. 

"It  will  be  presumed  that  the  tangible  assets  em- 
ployed in  the  trade  or  business  have  been  acquired  with 
cash,  which  has  been  either  paid  in  directly  or  derived 
from  earnings  of  the  trade  or  business;  but  the  tax- 
payer will  be  entitled  to  show  such  assets  were  paid  in 
as  tangible  property."     (Eeg.  41,  Art.  67.) 

Depreciation  of  tangible  property. — The  same  general 
rules  apply  to  the  depreciation  of  the  tangible  property 
of  an  individual  as  have  been  previously  explained  in 
the  determination  of  the  "invested  capital"  of  corpora- 
tions and  partnerships.     (See  page  677,  ante.) 

Valuation  of  intangible  property. — Intangible  assets  of 
an  individual,  such  as  patents  and  copyrights,  and  good- 
will, trade-marks,  trade  brands  and  franchises,  "may 
be  included  in  invested  capital  at  a  value  not  to  exceed 
the  actual  cash  paid  therefor  as  the  actual  cash  value 
at  the  time  of  payment  of  the  tangible  property  paid 
therefor,  but  only  if  bona-fide  payment  was  made  there- 
for specifically  as  such  in  cash  or  tangible  property." 
(Reg.  41,  Art.  68.)  The  italics  are  the  writer's,  to  bring 
out  the  important  part  of  the  regulation.  Payment 
must  have  been  made  specifically  for  the  intangible 
property,  and  not  for  another  account,  such  as  adver- 
tising or  expense.  It  is  interesting  to  note  that  the  20 
per  cent  limitation  placed  upon  the  value  of  the  in- 
tangible assets  of  a  corporation  or  partnership  in  the 
computation  of  its  "invested  capital"  does  not  apply  to 
individuals. 

Profits  earned  during  taxable  year, — We  have  seen  that 
corporations  and  partnerships  are  not  permitted  to  in- 
clude as  invested  capital  any  profits  earned  during  the 
taxable  year.    Individuals,  however,  may  do  so. 


EXCESS   PROFITS    TAX  687 

The  profits  of  the  taxable  year  remaining  in  the 
trade  or  business  are  considered  to  have  arisen  ratably 
during  the  year.  The  amount  of  these  earnings  that 
may  be  included  in  the  invested  capital  is  the  total 
amount  of  such  earnings  averaged  monthly  over  the 
year.  To  illustrate:  the  undivided  profits  of  an  indi- 
vidual earned  during  a  taxable  year  and  remaining  in 
the  business  at  the  close  of  that  year  amount  to  $24,000. 
The  Eegulations  assume  that  this  has  been  earned 
ratably  during  the  year;  in  other  words,  that  $2,000  of 
it  was  earned  during  the  first  month,  $2,000  during  the 
second  month,  $2,000  during  the  third  month,  etc.  The 
amounts  of  such  earnings  would  therefore  be  as  follows 
at  the  end  of  each  month: 

First  month $2,000 

Second  month 4,000 

Third  month 6,000 

Fourth  month 8,000 

Fifth  month 10,000 

Sixth  month 12,000 

Seventh  month 14,000 

Eighth  month 16,000 

Ninth  month 18,000 

Tenth  month 20,000 

Eleventh  month 22,000 

Twelfth  month  24,000 


12  )$156,000(  $13,000 

The  average  amount  is  therefore  $13,000,  which  may 
be  included  by  the  individual  in  his  invested  capital.  A 
simpler  method  of  determining  this  amount  is  to  add 
the  ratable  amount  for  first  month,  $2,000,  to  the  total 
for  the  twelve  months,  $24,000,  and  divide  the  result, 
$26,000,  by  two,  since  the  average  of  any  arithmetic 
progression  is  one-half  the  sum  of  the  first  and  last 
numbers. 


688  INCOME   AND   FEDERAL    TAX   REPORTS 

Computation  of  invested  capital. — Two  methods  for  de- 
termining the  invested  capital  of  an  individual  are  pre- 
scribed, the  choice  of  which  is  dependent  upon  whether 
or  not  the  individual  keeps  books  of  account. 

If  the  individual  does  keep  such  books,  the  amount  of 
his  invested  capital  appears  in  the  capital  account  (pro- 
prietorship or  whatever  it  may  be  called).  This  amount 
is  subject  to  the  adjustments  previously  mentioned,  and 
must  not  exceed  the  total  of  the  admissible  assets  on 
the  books  of  the  individual.  Otherwise  the  invested 
capital  must  be  the  amount  of  such  assets.  Admissible 
assets  have  been  explained  previously  under  the  in- 
vested capital  computations  of  corporations  and  part- 
nerships. 

If  the  individual  does  not  keep  books  of  account  "he 
should  prepare  and  preserve  a  statement  as  at  the  be- 
ginning of  the  taxable  year  and  as  the  end  of  the  tax- 
able year,  showing  in  full  all  his  assets  valued  in  ac- 
cordance with  these  regulations  (see  page  663,  ante), 
and  all  his  liabilities.  The  excess  of  such  assets  over 
such  liabilities  at  the  beginning  of  the  year  and  again 
at  the  end  of  the  year  will  constitute  the  invested  cap- 
ital of  the  individual  on  those  dates,  respectively,  pro- 
vided, that  in  each  case  the  assets  other  than  those  not 
allowed  to  be  included,  equal  or  exceed  the  amount  of 
such  excess.  Otherwise,  the  invested  capital  shall  be 
the  amount  of  such  assets. 

"The  amount  of  the  difference  between  the  capital 
thus  shown  as  at  the  beginning  of  the  year  and  at  the 
end  of  the  year  will,  in  the  absence  of  evidence  to  the 
contrary,  be  deemed  to  have  arisen  ratably  during  the 
year,  and  the  capital  at  the  beginning  of  the  year  will 
be  increased  or  decreased,  as  the  case  may  be,  by  such 
amount  averaged  monthly  over  the  year."  (See  page 
663,  ante.) 

Individual  engaged  in  more  than  one  business. — If  an 
individual  is  engaged  in  more  than  one  trade  or  busi- 


EXCESS   PROFITS    TAX  689 

ness  having  invested  capital,  his  total  invested  capital 
will  be  considered  as  being  the  total  invested  capital  of 
all  the  businesses.  This  applies  apparently  to  an  indi- 
vidual solely  interested  in  more  than  one  business,  and 
under  such  a  condition  he  makes  a  single  return  in 
Class  B.  The  average  individual  who  may  be  interested 
in  more  than  one  business,  one  having  a  nominal  capital 
or  no  capital  at  all,  would  probably  come  in  both  Class 
A  and  Class  B.  The  income  from  his  principal  busi- 
ness would  be  determined  as  explained  under  Net  In- 
come of  Individuals,  and  his  invested  capital  in  the 
business  would  be  determined  as  just  explained,  and 
the  return  would  come  in  Class  B.  The  income  from 
his  other  interests  would  be  probably  reportable  under 
Class  A.     (See  page  645,  et  seq.) 

Assets  and  liabilities  of  individual  restricted. — The  term 
"assets"  and  "liabilities,"  as  applied  to  an  individual 
under  the  Excess  Profits  Tax  law,  relate  only  to  the 
assets  and  liabilities  of  his  trade  or  business,  and  not  to 
his  personal  assets  and  liabilities.     (Reg.  41,  Art.  70.) 

When  invested  capital  will  be  deemed  indeterminable. — 
In  certain  cases,  the  law  and  regulations  provide  that 
invested  capital,  as  calculated  under  the  law,  shall  not 
be  considered  the  invested  capital  of  the  concern,  but 
the  Secretary  of  the  Treasury  may  decide  that  the  in- 
vested capital  cannot  be  determined.  The  Regulations 
give  a  number  of  instances  where  such  cases  may  arise. 

1.  Where,  through  defective  accounting  or  the  lack  of 
adequate  data,  it  is  impossible  accurately  to  compute  the 
invested  capital. 

2.  Where,  upon  application  by  a  foreign  taxpayer, 
the  Secretary  of  the  Treasury  finds  that  the  expense  of 
securing  the  data  necessary  for  the  computation  of  the 
invested  capital  would  be  unreasonable  in  view  of  the 
amount  of  the  tax  involved,  or  that  it  is  impracticable 
to  determine  either  the  "entire  invested  capital"  or  the 
"entire  net  income." 


690        INCOME   AND    FEDERAL    TAX    REPORTS 

3.  Where  long-established  concerns  have  practised 
ultra-conservative  accounting,  and  have  charged  items 
to  expense,  such  as  the  cost  of  trade-marks,  advertising 
expenditures,  and  the  like,  and  therefore  have  a  small 
good-will  account  as  compared  with  representative  con- 
cerns that  have  made  liberal  charges  against  capital  for 
these  items,  the  ultra-conservative  concerns  are  likely 
to  be  placed  at  a  serious  disadvantage  and  may  there- 
fore claim  the  benefit  of  the  rule  applying  to  concerns 
whose  invested  capital  cannot  be  determined. 

4.  Where  the  invested  capital  is  seriously  dispropor- 
tionate to  the  taxable  income.  Such  cases  may  arise 
through : 

(a)  The  realization  in  one  year  of  the  earnings  of  cap- 
ital unproductively  invested  through  a  period  of  years 
or  of  the  fruits  of  activities  antedating  the  taxable 
year;  or, 

(b)  Inability  to  recognize  or  properly  to  allow  for 
amortization,  obsolescence,  or  exceptional  depreciation 
due  to  the  present  war,  or  to  the  necessity  in  connec- 
tion with  the  present  war,  of  providing  a  plant  which 
will  not  be  wanted  for  the  purpose  of  the  trade  or  busi- 
ness after  the  termination  of  the  war. 

DETERMINATION  OF  THE  AMOUNT  OF  THE  GRADUATED  TAX 

Summary. — We  can  assume  now  that  the  following 
facts  have  been  determined:  (1)  the  pre-war  income; 
(2)  the  pre-war  capital;  (3)  the  net  income  of  the  tax- 
able year,  and  (4)  the  invested  capital  in  the  taxable 
year.  From  these  we  can  determine  (5)  the  pre-war 
rate  of  profits,  and  (6)  the  rate  of  profits  in  the  tax- 
able year. 

To  find  the  tax  to  which  a  corporation  or  foreign 
partnership  is  liable,  we  must  find  what  its  "specific 
exemption"  is  and  what  its  "deduction"  is. 

Specific  exemptions. — The  specific  exemptions  are  aa 
follows:  domestic  corporations,  $3,000;  domestic  partner- 


EXCESS    PROFITS    TAX  691 

ships,  residents  or  citizens,  $6,000.  Foreign  corporations 
and  partnerships  and  non-resident  aliens  are  not  en- 
titled to  any  specific  exemptions. 

Deductions  —  in  ordinary  cases.  —  In  ordinary  cases, 
where  the  corporation  or  partnership  has  been  in  ex- 
istence or  where  the  individual  has  been  engaged  in 
business  or  trade  during  the  pre-war  period,  the  deduc- 
tion will  be  that  percentage  of  the  invested  capital  in 
the  taxable  year  which  is  determined  by  dividing  the 
pre-war  profits  by  the  pre-war  invested  capital.  In  no 
case,  however,  may  this  percentage  be  less  than  7  per 
cent  or  more  than  9  per  cent. 

Example:  Pre-war  profits,  $10,000;  pre-war  capital, 
$100,000;  taxable  year  profits,  $50,000;  taxable  year 
capital,  $200,000.  Deduction:  9  per  cent  of  $200,000 
(since  the  pre-war  rate  of  profits  was  10  per  cent,  the 
deduction  rate  will  be  the  maximum,  9  per  cent).  If 
in  the  foregoing  example  the  pre-war  profits  had  been 
$6,000,  the  deduction  would  be  7  per  cent  of  $200,000, 
since  the  pre-war  rate  would  be  6  per  cent,  and  the  law 
states  the  minimum  to  be  7  per  cent.  Notice  that  the 
pre-war  capital  and  the  pre-war  profits  are  to  be  taken 
as  a  whole.  Thus,  if  in  the  years  1911,  1912,  and  1913, 
the  capital  was  $100,000,  $200,000  and  $300,000  respec- 
tively, and  the  pre-war  profits  were  $10,000,  $20,000 
and  $60,000,  the  rate  of  profits  for  the  pre-war  period 
would  be  ($100,000  +  $200,000  +  $300,000)  --  3  -  $200,- 
000,  divided  into  $10,000  +  $20,000  +  $60,000  -f-  3  =  $30,- 
000,  giving  15  per  cent.  Some  people  may  possibly 
assume  that  the  rate  of  profits  would  be  the  average  of 
the  rates  for  each  of  the  three  years,  i.e.,  10%  + 10%  + 
20%  -f-  3  —  13^%.  That  method  of  finding  the  pre-war 
rate  of  profits  clearly  is  wrong. 

Deductions  where  corporation  or  partnership  was  not  in 
existence  or  individual  not  in  business  during'  the  pre-war 
period. — In  cases  where  the  concern  was  not  in  exist- 


692  INCOME  AND   FEDERAL   TAX  REPORTS 

ence  as  such  the  deduction  will  consist  of  8  per  cent 
of  the  invested  capital  in  the  taxable  year. 

Example:  A  corporation  was  organized  in  1915.  Its 
invested  capital  in  1917  was  $100,000.  Its  deduction 
would  be  $8,000. 

Notice  that  if  this  corporation  was  a  reorganization 
of  a  company  organized  in  1910,  and  remained  substan- 
tially in  the  control  of  the  same  interests,  the  latter' s 
invested  capital  during  1911,  1912  and  1913  and  its 
profits  during  those  years  would  determine  the  percent- 
age of  the  invested  capital  to  be  taken  as  a  deduction. 
(Section  204.) 

Deductions  where  a  concern  has  no  income  or  subnormal 
income  during  the  pre-war  period. — What  is  subnormal 
income  is  for  the  Secretary  of  the  Treasury  to  deter- 
mine in  each  case  after  due  consideration  has  been 
given  to  the  earnings  of  the  given  corporation  and  to  the 
earnings  of  representative  concerns  engaged  in  the 
same  line  of  business.  The  deduction  in  the  return  will 
be  figured  out  in  the  ordinary  way,  but  a  claim  will  be 
made  for  abatement  and  filed  with  the  return. 

Two  questions  arise  here:  (1)  when  are  earnings  sub- 
normal? (2)  what  are  the  earnings  of  representative 
firms  ?  Both  of  these  questions,  in  fact,  hinge  on  the 
question,  what  is  normal  for  the  general  run  of  con- 
cerns engaged  in  the  same  line  of  business?  In  the 
final  analysis  the  question  will  be  determined  by  the 
Commissioner  of  Internal  Eevenue,  who,  in  accordance 
with  regulations  prescribed  by  him,  and  with  the  ap- 
proval of  the  Secretary  of  the  Treasury,  is  to  determine 
the  percentage  which  the  net  income  was  of  the  in- 
vested capital  in  each  trade  or  business. 

Example:  Company  A  had  an  invested  capital  of 
$1,000,000  and  net  earnings  of  $60,000  during  the  pre- 
war period.  It  happened  that  ordinarily  its  earnings 
are  more  than  6  per  cent  of  its  capital  and  that  other 
concerns  in  the  same  line  of  business  made  above  9  per 


EXCESS   PROFITS    TAX  693 

cent  on  their  invested  capital  during  the  pre-war  period. 
A  would  file  its  return  in  the  usual  way,  but  would  file 
a  claim  for  abatement,  asking  that  its  tax  be  fixed  on 
the  basis  of  a  9  per  cent  deduction  instead  of  a  7  per 
cent  deduction. 

Deduction  where  the  Secretary  of  the  Treasury  cannot  sat- 
isfactorily determine  invested  capital. — Provision  is  made 
for  cases  where  the  government  cannot  satisfactorily  de- 
termine the  invested  capital  of  a  given  concern.  In 
such  cases  the  deduction  shall  be  an  amount  equal  to 
the  same  proportion  of  the  net  income  of  the  trade  or 
business  received  during  the  taxable  year  as  the  aver- 
age deduction  (decided  in  the  same  manner  as  was  de- 
scribed in  the  foregoing  section)  for  the  same  calendar 
year  of  representative  concerns  engaged  in  the  same 
business  bears  to  the  total  net  income  of  the  business 
received  by  such  concerns.  Where  a  corporation  or 
partnership  uses  a  fiscal  year  of  its  own,  the  basis  of 
the  deduction  shall  be  the  same  as  though  its  fiscal  year 
had  been  the  calendar  year  which  terminated  in  its 
fiscal  year. 

Example:  Company  A  has  a  fiscal  year  ending  June 
30,  1917.  Its  capital  cannot  satisfactorily  be  ascer- 
tained. The  deduction  will  be  that  proportion  of  its 
net  income  as  was  found  for  the  calendar  year  ending 
December  31,  1916,  in  representative  concerns  in  the 
same  line  of  business  by  dividing  their  deduction  by 
their  net  income. 

Rate  of  tax. — The  rate  of  tax  is  graduated,  and  the 
tax  itself  is  found  for  concerns  with  invested  capital 
subject  to  the  conditions  described  in  the  foregoing  sec- 
tions on  deductions,  in  the  following  manner:  (1)  Di- 
vide the  net  income  in  the  taxable  year  into  different 
classes  or  brackets,  the  first  bracket  being  all  the  net 
income  up  to  and  including  15  per  cent  of  the  invested 
capital;  (2)  all  the  net  income  in  excess  of  15  per  cent 
of  the  capital  and  not  in  excess  of  20  per  cent  of  the 


694  INCOME  AND   FEDERAL    TAX  REPORTS 

capital;  (3)  all  the  net  income  in  excess  of  20  per  cent 
and  not  in  excess  of  25  per  cent  of  the  capital;  (4)  all 
the  net  income  .in  excess  of  25  per  cent  and  not  in  ex- 
cess of  33  per  cent  of  the  capital;  and  (5)  all  the  net 
income  in  excess  of  33  per  cent. 

After  these  brackets  have  been  computed  the  deduc- 
tion and  exemption  are  subtracted  first  from  the  first 
bracket,  and  if  the  deduction  plus  the  exemption  is 
greater  than  the  first  bracket,  nothing  further  is  done 
about  that  bracket,  but  the  difference  between  the  de- 
duction plus  the  exemption  and  the  amount  of  the  first 
bracket  is  subtracted  from  the  second  bracket  and  so 
on  till  the  deduction  plus  the  exemption  has  been  ex- 
hausted. Whatever  remains  in  each  bracket  after  this 
has  been  done  is  then  taxed  at  the  following  rates:  for 
the  first  bracket,  20  per  cent ;  second,  25  per  cent ;  third, 
35  per  cent;  fourth,  45  per  cent;  and  fifth,  60  per  cent. 

Example:  Company  A's  pre-war  rate  of  profits  was 
10  per  cent;  the  invested  capital  for  the  taxable  year 
was  $24,000  and  the  net  income  for  the  taxable  year 
was  $25,000.  A's  deduction  would  be  $2,160  (9  per  cent 
of  $24,000)  and  its  specific  exemption  (A  being  a  domes- 
tic corporation),  $3,000. 


Deduction  and 

Exemption 

racket 

Am't.  in 

applicable  to 

Amount 

Amount 

No. 

Bracket 

Bracket 

Taxable 

Rate 

Tax 

1 

$3,600 

$3,600 

0 

20% 

0 

2 

1,200 

1,200 

0 

25 

0 

3 

1,200 

360 

840 

35 

294 

4 

1,920 

1,920 

45 

864 

5 

17,080 

17,080 

60 

10,248 

Total  $25,000  $5,160  $19,840  $11,406 

The  return  covering  trade  or  business  with  invested 
capital  will  be  made  on  Forms  1101,  1102  and  1103. 

Computation  of  tax  for  fiscal  year,  part  of  which  falls  in 
1916. — If  a  corporation  or  partnership  makes  a  return 
for  a  fiscal  year  part  of  which  falls  within  the  calendar 
year  1916,  the  tax  for  the  first  taxable  year  is  that  pro- 


EXCESS   PROFITS    TAX  695 

portion  of  the  tax  computed  upon  the  net  income  for 
such  fiscal  year  which  the  number  of  months  from  Jan- 
uary 1,  1917,  to  the  end  of  such  fiscal  year  bears  to  the 
entire  number  of  months  in  such  fiscal  year.  (Reg.  41, 
Art.  19.) 

Computation  of  tax  for  period  less  than  12  months. — If 
a  corporation  or  partnership  makes  a  return  for  any 
reason  for  a  period  of  less  than  12  months,  the  deduc- 
tion and  exemption  allowed  will  be  an  amount  which 
bears  the  same  ratio  to  the  deduction  allowable  for  a 
full  year  as  the  number  of  months  in  such  period  bears 
to  12  months. 

DETERMINATION  OF  TAX  WHERE  INVESTED    CAPITAL  IS 
NOMINAL  OR  WHERE  THERE  IS  NO   INVESTED   CAPITAL 

Rate  of  tax  in  cases  without  capital. — Where  a  concern 
without  invested  capital  or  with  nominal  capital  only, 
or  an  individual  engaged  in  an  occupation  or  profession 
without  capital,  comes  under  the  rules  already  given 
for  determining  who  is  subject  to  the  tax  (e.g.,  domes- 
tic corporations  with  incomes  of  $3,000  and  citizens 
with  incomes  of  $6,000,  etc.),  the  rate  of  tax  is  8  per 
cent,  and  it  is  imposed  on  the  net  income  for  the  tax 
year  in  excess  of  $3,000  in  the  case  of  domestic  cor- 
porations, and  in  excess  of  $6,000  in  the  case  of  domes- 
tic partnerships  and  citizens  and  residents.  The  rate  of 
tax  on  foreign  corporations  and  partnerships  and  non- 
resident aliens  is  8  per  cent  on  the  entire  net  income, 
from  sources  within  the  Unitpd  States.  However,  inas- 
much as  foreign  partnerships  are  not  required  to  file  a 
return  unless  their  net  income  is  $3,000  or  more  (Sec. 
211),  it  appears  that  no  tax  will  be  paid  by  a  foreign 
partnership  having  a  net  income  of  $2,999.99. 

Example:  M,  a  citizen  or  resident,  owns  a  store  with  an  invested  capital 
of  $10,000,  the  net  income  of  which  is  $9,000.  He  also  owns  a  farm,  em- 
ploying a  capital  of  $12,000,  the  net  income  of  which  is  $7,000.  He  also 
receives  a  salary  of  $4,000  as  president  of  a  hank,  and  $3,000  as  special 
counsel.     Assume  that  in  the  businesses  employing  capital  he  is  entitled 


696  INCOME  AND   FEDERAL   TAX  REPORTS 

to  the  maximum  deduction  of  9  per  cent.  M  allows  himself  a  salary  of 
$3,000  for  managing  the  store  and  $2,500  for  managing  the  farm.  M  also 
receives  $1,000  in  dividends.  This  $1,000  is  not  taxable,  as  it  is  derived 
from  an  investment  not  connected  with  his  trade.  M  will  make  out  two 
returns,  (a)  for  income  from  salaries  and  compensation  from  services,  and 
(b)  for  income  from  trade  or  business  employing  invested  capital.  In  (a) 
he  would  include  the  $4,000  salary,  the  $3,000  fees  and  the  $3,000  and 
$2,500  salaries,  making  a  total  of  $12,500.  This  may  be  reported  on  Form 
1040.  The  excess  profits  tax  will  be  8  per  cent  of  $6,500  ($12,500 — $6,000, 
the  specific  exemption),  or  $520.  The  (b)  income  will  be  reported  on 
Form  1101.  M  will  report  on  this  form  a  net  income  of  $6,000  from  store 
($9,000— $3,000  salary),  and  $4,500  from  farm  ($7,000— $2,500  salary), 
total  $10,500.  From  this  is  deducted  a  specific  exemption  of  $6,000  and 
the  deduction  of  $1,980  (9  per  cent  on  $22,000,  i.e.,  $10,000  capital  in  store 
plus  $12,000  capital  in  farm).  The  balance,  $2,520,  is  taxable  at  the  grad- 
uated rates  mentioned  on  p.  683. 

ADMINISTRATIVE  PROVISIONS 

When  returns  are  to  be  filed. — Returns  for  the  Excess 
Profits  tax  are  due  at  the  same  time  as  those  for  the 
Income  tax.  Upon  application  to  the  proper  Collector 
of  Internal  Eevenue  returns  of  corporations  and  part- 
nerships may  be  based  on  a  fiscal  year  other  than  the 
calendar  year  and  in  such  event  the  returns  are  due 
within  60  days  after  the  close  of  the  fiscal  year. 

Information  to  be  furnished  by  affiliated  corporations. — 
Reg.  41,  Art.  77,  provides: 

For  the  purpose  of  the  excess  profits  tax  every  corporation  will  describe 
in  its  return  all  its  intercorporate  relationships  with  other  corporations 
with  which  it  is  affiliated,  and  will  furnish  such  information  in  relation 
thereto  as  will  enable  the  Commissioner  of  Internal  Revenue  to  compute 
the  amount  of  the  tax  properly  due  from  each  corporation  on  the  basis 
of  an  equitable  and  lawful  accounting. 

For  the  purpose  of  this  regulation  two  or  more  corporations  will  be 
deemed  to  be  affiliated  ( 1 )  when  one  such  corporation  owns  directly  or  con- 
trols through  closely  affiliated  interests  or  by  a  nominee  or  nominees,  all 
or  substantially  all  of  the  stock  of  the  other  or  others,  or  when  substan- 
tially all  of  the  stock  of  two  or  more  corporations  is  owned  by  the  same 
individual  or  partnership,  and  both  or  all  of  such  corporations  are  en- 
gaged in  the  same  or  a  closely  related  business;  or  (2)  when  one  such 
corporation  (a)  buys  from  or  sells  to  another  products  or  services  at 
prices  above  or  below  the  current  market,  thus  effecting  an  artificial  dis- 
tribution of  profits,  or  (b)  in  any  way  so  arranges  its  financial  rela- 
tionship with  another  corporation  as  to  assign  to  it  a  disproportionate 
share  of  net  income  or  invested  capital. 


EXCESS    PROFITS    TAX  697 

Consolidated  concerns  may  be  required  to  make  consoli- 
dated return. — Beg.  41.  Art.  77,  provides  that: 

Whenever  necessary  to  more  equitably  determine  the  invested  capital 
or  taxable  income,  the  Commissioner  of  Internal  Revenue  may  require  cor- 
porations classed  as  affiliated  under  the  foregoing  rule  to  furnish  a  con- 
solidated return  of  net  income  and  invested  capital. 

Where  such  consolidated  return  is  required  it  may  be  made  by  any  one 
or  more  of  such  corporations  or  by  all  of  them  acting  jointly;  but  if  such 
affiliated  corporations,  when  requested  to  file  such  consolidated  returns, 
neglect  or  refuse  to  do  so,  the  Commissioner  of  Internal  Revenue  may 
cause  an  examination  of  the  books  of  all  such  corporations  to  be  made 
and  a  consolidated  statement  to  be  made  from  such  examination.  In 
cases  where  consolidated  returns  are  accepted,  the  total  tax  will  be  com- 
puted in  the  first  instance  as  a  unit  upon  the  basis  of  the  consolidated 
return  and  will  be  assessed  upon  the  respective  affiliated  corporations  in 
such  proportions  as  may  be  agreed  among  them.  If  no  such  agreement 
is  made  the  tax  will  be  assessed  upon  each  such  corporation  in  accordance 
with  the  net  income  and  invested  capital  properly  assignable  to  it. 

When  tax  is  to  be  paid. — The  tax  is  payable  on  or  be- 
fore June  15th  in  each  year.  Corporations  and  part- 
nerships filing  returns  based  on  a  fiscal  year  instead  of 
the  calendar  year  must  pay  the  tax  within  105  days 
after  the  return  is  due. 

Credit  for  taxes  under  the  law  of  March  3,  1917. — In 
certain  cases,  where  corporations  or  partnerships  had 
a  fiscal  year  other  than  the  calendar  year  reports  were 
made  during  1917  under  the  provision  of  the  Excess 
Profits  Tax  law  of  March  3,  1917,  and  the  amount  of 
the  tax  assessed  and  paid.  Since  that  law  has  been 
repealed  by  the  law  of  October  3,  1917,  provision  was 
made  in  the  latter  law,  that  amounts  so  paid  shall  be 
credited  toward  the  payment  of  the  tax  imposed  by  the 
law  of  October  3,  1917,  and  if  the  amount  so  paid  ex- 
ceeds the  amount  of  the  tax,  the  excess  shall  be  re- 
funded as  a  tax  erroneously  or  illegally  collected. 

Partnership  tax,  how  paid  and  deducted  for  Income  Tax 
computation. — It  will  be  remembered  that  partnerships 
as  such  pay  the  Excess  Profits  tax,  but  not  the  Income 
tax.  Since  a  person  paying  the  Income  tax  is  entitled 
to  subtract  the  amount  of  the  Excess  Profits  tax  from 


698  INCOME   AND   FEDERAL    TAX  REPORTS 

income  before  arriving  at  the  amount  of  net  income 
taxable  under  the  Income  tax  law,  the  partners  should 
calculate  the  Excess  Profits  tax  for  the  partnership  and 
each  partner  should  give  himself  credit  for  that  propor- 
tion of  the  tax  in  calculating  his  net  income  for  Income 
tax  purposes  as  his  share  in  the  business  bears  to  the 
entire  proprietorship. 

Claims  for  abatement. — If  a  taxpayer  files  a  claim  for 
abatement  of  taxes  on  Form  47  (see  p.  655,  et  seq.), 
collection  of  the  portion  of  the  tax  covered  by  the  claim 
in  abatement  will  not  be  made  till  a  decision  is  rendered 
on  the  merits  of  the  claim.  If,  however,  the  Commis- 
sioner of  Internal  Eevenue  deems  it  advisable,  he  may 
require  a  bond  for  the  payment  of  the  amount  with- 
held as  an  abatement.  If  in  such  cases  a  bond  is  de- 
manded and  not  furnished  the  full  amount  of  the  tax 
will  be  required.  If,  thereafter,  the  claim  is  decided 
favorably  to  the  taxpayer,  a  refund  of  the  amount  will 
be  made. 

Penalties. — Since  the  Excess  Profits  law  provides  that 
all  administrative,  special  and  general  provisions  of 
law,  including  the  laws  in  relation  to  the  assessment, 
remission,  collection  and  refund  of  internal  revenue 
taxes  not  inconsistent  with  this  law,  as  well  as  those 
provisions  of  the  Income  Tax  law  applicable  to  returns 
and  payment,  including  penalties,  are  made  applicable 
to  the  Excess  Profits  tax,  the  reader  is  referred  to  the 
chapter  on  the  administration  of  the  Income  Tax  for 
explanation  of  penalties,  etc.,  under  this  law.  (See 
Chapter  II.) 

Extension  of  time  for  filing  returns  on  basis  of  fiscal  year. 
— A  universal  extension  of  time  to  April  1,  1918,  to  file 
returns  has  been  granted  to  all  corporations  and  part- 
nerships making  returns  based  on  a  fiscal  year  ending 
during  1917.  The  law  requires  returns  to  be  made 
within  60  days  after  the  fiscal  year  closes,  but  this  ex- 
tension has  been  necessary  on  account  of  the  delay  in 
issuing  the  official  forms. 


WAR  EXCESS  PROFITS  TAX 
REGULATIONS  NO.   41 


DEFINITIONS 

Article  I.  Definitions. — When  used  in  these  regulations  the  terms  de- 
fined in  articles  2  to  9,  inclusive,  shall,  unless  otherwise  indicated  by  the 
context,  be  deemed  to  be  used  only  with  the  scope  or  meaning  ascribed 
to  them  respectively  in  such  articles. 

2.  Corporation. — The  term  "corporation"  includes  joint-stock  com- 
panies or  associations,  no  matter  how  created  or  organized,  insurance 
companies,  and  limited  partnerships. 

3.  Domestic  and  foreign. — The  term  ' '  domestic ' '  means  created  under 
the  law  (statutory  or  other)  of  the  United  States  or  any  State  thereof, 
Alaska,  Hawaii,  or  the  District  of  Columbia,  and  the  term  "foreign" 
means  created  under  the  law  (statutory  or  other)  of  any  other  posses- 
sion of  the  United  States  or  of  any  foreign  country  or  government. 

4.  United  States. — The  term  "United  States"  (when  used  in  a  geo- 
graphical sense)  means  only  the  States  thereof,  Alaska,  Hawaii,  and  the 
District  of  Columbia. 

5.  Taxable  year. — The  term  "taxable  year"  means  the  12  months 
ending  December  31  of  each  year,  except  in  the  case  of  a  corporation  or 
partnership  which  has  fixed  its  own  fiscal  year,  in  which  case  it  means 
such  fiscal  year.  The  first  taxable  year  is  the  year  ending  December  31, 
1917,  except  that  in  the  case  of  a  corporation  or  partnership  which  has 
fixed  its  own  fiscal  year,  the  first  taxable  year  is  the  fiscal  year  ending 
during  the  calendar  year  1917.  (For  special  provisions  as  to  prorating 
the  amount  of  tax  due  for  the  portion  of  any  fiscal  year  ending  during 
the  calendar  year  1917,  see  articles  19  and  20.) 

6.  Pre-war  period. — The  term  "pre-war  period"  means  the  calendar 
years  1911,  1912,  and  1913,  or  if  a  corporation  or  partnership  was  not 
in  existence  or  an  individual  was  not  engaged  in  the  trade  or  business 
during  the  whole  of  such  three  years,  then  as  many  of  such  years  dur- 
ing the  whole  of  which  the  corporation  or  partnership  was  in  existence 
or  the  individual  was  engaged  in  the  trade  or  business. 

7.  "Trade,"  "business,"  "trade  or  business"  in  case  of  corporations 
and  partnerships. — In  the  case  of  a  corporation  or  partnership  all  in- 
come from  whatever  source  derived  is  deemed  to  be  received  from  its 
trade  or  business,  and  the  terms  "trade,"  "business,"  and  "trade  or 
business"  include  all  sources  of  income. 

8.  "Trade"  in  the  case  of  individuals. — In  the  case  of  an  individual, 
the  terms  "trade,"  "business,"  and  "trade  or  business"  comprehend 
all  his  activities  for  gain,  profit,  or  livelihood,  entered  into  with  suffi- 
cient frequency,  or  occupying  such  portion  of  his  time  or  attention  as 
to  constitute  a  vocation,  including  occupations  and  professions.  When 
such  activities  constitute  a  vocation  they  shall  be  construed  to  be  a 
trade  or  business  whether  continuously  carried  on  during  the  taxable 
year  or  not,  and  all  the  income  arising  therefrom  shall  be  included  in 
his  return  for  excess-profits  tax. 

699 


700  INCOME    AND    FEDERAL    TAX    REPORTS 

In  the  following  cases  the  gain  or  income  is  not  subject  to  excess- 
profits  tax,  and  the  capital  from  which  such  gain  or  income  is  derived 
shall  not  be  included  in  "invested  capital":  (a)  Gains  or  profits  from 
transactions  entered  into  for  profit,  but  which  are  isolated,  incidental, 
or  so  infrequent  as  not  to  constitute  an  occupation,  and  (b)  the  income 
from  property  arising  merely  from  its  ownership,  including  interest,  rent, 
and  similar  income  from  investments  except  in  those  cases  in  which  the 
management  of  such  investments  really  constitutes  a  trade  or  business. 

9.  "Dividend." — The  term  "dividend"  has  the  same  meaning  as  in 
section  31  of  the  act  of  September  8,  1916,  as  amended  by  the  act  of  Oc- 
tober 3,  1917.     (See  Income  Tax  Eegulations,  art.  106.) 

CORPORATIONS,    PARTNERSHIPS   AND    INDIVIDUALS    SUBJECT 

TO  THE   TAX 

10.  Corporations. — Every  domestic  corporation  which  has  for  the  tax- 
able year  a  net  income  of  $3,000  or  more  is,  unless  exempt  under  article 
13,  required  to  make  a  return  and  to  pay  the  tax,  if  any. 

Every  foreign  corporation  which  has  for  the  taxable  year  a  net  income 
of  $3,000  or  more  from  sources  within  the  United  States  is,  unless  ex- 
empt under  article  13,  required  to  make  a  return  and  to  pay  the  tax,  if 
any. 

11.  Partnerships. — Every  domestic  partnership  which  has  for  the  tax- 
able year  a  net  income  of  $6,000  or  more  is,  unless  exempt  under  article 
13,  required  to  make  a  return  and  to  pay  the  tax,  if  any. 

Every  foreign  partnership  which  has  for  the  taxable  year  a  net  in- 
come of  $3,000  or  more  from  sources  within  the  United  States  is,  unless 
exempt  under  article  13,  required  to  make  a  return  and  to  pay  the  tax, 
if  any. 

12.  Individuals. — Every  citizen  or  resident  of  the  United  States  who 
has  for  the  taxable  year  an  aggregate  net  income  in  excess  of  $6,000 
from  trades,  businesses,  occupations  or  professions,  is,  unless  exempt  un- 
der article  13,  required  to  make  a  return  and  to  pay  the  tax,  if  any. 

Every  non-resident  alien  individual  who  has  for  the  taxable  year  an 
aggregate  net  income  of  $3,000  or  more  from  trades,  businesses,  occupa- 
tions, or  professions  carried  on  within  the  United  States,  is,  unless  ex- 
empt under  article  13,  required  to  make  a  return  and  to  pay  the  tax,  if 
any. 

13.  Exemptions. — The  following  are  exempt  from  the  tax: 

(a)  Corporations  exempt  under  the  provisions  of  section  11  of  Title  I 
of  the  act  of  September  8,  1916,  from  the  tax  imposed  by  such  title. 
(See  Income  Tax  Regulations,  arts.  67,  ff.) 

(b)  Partnerships  carrying  on  or  doing  the  same  kind  of  business  or 
coming  within  the  same  description. 

(c)  Individuals  to  the  extent  that  they  carry  on  or  do  the  same  kind 
of  business  or  come  within  the  same  description. 

RATES    AND    COMPUTATION    OF    TAX 

14.  Classification  of  net  income. — For  the  purposes  of  the  excess  profits 
tax  net  income  which  is  subject  to  the  tax  shall  be  divided  into  two 
classes,  as  follows: 

A.  Net  income  which  is  derived  from  a  trade  or  business  having  no 
invested  capital,  or  not  more  than  a  nominal  capital,  including,  in  the 
case  of  an  individual,  salaries,  wages,  fees,  or  other  compensations;  and 

B.  Net  income  which  is  derived  from  a  trade  or  business  having  in- 
vested capital. 

In  the  case  of  a  corporation  or  partnership,  all  the  trades  and  busi- 
nesses in  which  it  is  engaged  will  be  treated  as  a  single  trade  or  business 


WAR   EXCESS   PROFITS    TAX  70 1 

(as  provided  in  sec.  201),  and  its  entire  income  will  be  held  to  be  of 
the  same  class  as  the  income  from  its  principal  trade  or  business. 

In  the  case  of  an  individual,  the  net  income  subject  to  the  excess 
profits  tax  shall  be  classified  as  provided  in  this  article.  Net  income  of 
class  A  shall  be  taxed  as  provided  in  article  15,  and  net  income  of  class 
B  shall  be  taxed  as  provided  in  article  16. 

15.  Bate  of  tax  on  income  of  class  A. — The  tax  upon  net  income  of 
class  A,  as  defined  in  article  14,  shall  be  computed  at  the  rate  of  8  per 
cent  upon  the  amount  thereof  in  excess  of  $3,000  in  the  case  of  a  do- 
mestic corporation;  upon  the  amount  thereof  in  excess  of  $6,000  in  the 
case  of  a  domestic  partnership  or  of  a  citizen  or  resident  of  the  United 
States;  and  upon  the  whole  thereof  in  the  case  of  a  foreign  corporation 
or  partnership  or  of  a  non-resident  alien  individual. 

16.  Rate  of  tax  on  income  of  class  B. — The  tax  upon  net  income  of 
class  B,  as  defined  in  article  14,  shall,  except  as  otherwise  provided  in 
article  17,  be  computed  at  the  following  rates: 

Twenty  per  cent  of  the  amount  of  the  net  income  in  excess  of  the 
deduction  (determined  as  provided  in  articles  21,  23  and  24)  and  not  in 
excess  of  15  per  cent  of  the  invested  capital  for  the  taxable  year; 

Twenty-five  per  cent  of  the  amount  of  the  net  income  in  excess  of 
15  per  cent  and  not  in  excess  of  20  per  cent  of  such  capital; 

Thirty-five  per  cent  of  the  amount  of  the  net  income  in  excess  of  20 
per  cent  and  not  in  excess  of  25  per  cent  of  such  capital; 

Forty-five  per  cent  of  the  amount  of  the  net  income  in  excess  of  25  per 
cent  and  not  in  excess  of  33  per  cent  of  such  capital; 

Sixty  per  cent  of  the  amount  of  the  net  income  in  excess  of  33  per 
cent  of  such  capital. 

Illustrations. — (1)  A  corporation  has  a  capital  of  $100,000,  pre-war 
earnings  of  7  per  cent,  and  a  net  income  for  the  taxable  year  of  $75,000. 

The  deduction  allowed  will  be  7  per  cent  of  the  capital,  or  $7,000,  plus 
$3,000  specific  deduction,  a  total  of  $10,000. 

The  amount  of  the  net  income  taxable  at  each  rate  will  be  as  follows: 

In  excess  of  the  deduction  and  not  in  excess  of  15  per  cent  of 

the  capital   (rate,  20  per  cent) $5,000 

In  excess  of  15  per  cent  of  the  capital  and  not  in  excess  of  20 

per  cent  thereof  (rate,  25  per  cent) 5,000 

In  excess  of  20  per  cent  of  the  capital  and  not  in  excess  of  25  per 

cent  thereof  (rate,  35  per  cent) 5,000 

In  excess  of  25  per  cent  of  the  capital  and  not  in  excess  of  33  per 

cent  thereof  (rate,  45  per  cent) 8,000 

In  excess  of  33  per  cent  of  the  capital  (rate,  60  per  cent) 42,000 

The  tax  would  then  be  computed  as  follows: 

20  per  cent  of  $5,000 $1,000 

25  per  cent  of  $5,000 1,250 

35  per  cent  of  $5,000 1,750 

45  per  cent  of  $8,000 3,600 

60  per  cent  of  $42,000 25,200 

Total  tax  $32,800 

(2)  An  individual  or  partnership  has  a  capital  of  $100,000,  pre-war 
earnings  of  8  per  cent,  and  a  net  income  for  the  taxable  year  of  $22,500. 

The  deduction  allowed  will  be  8  per  cent  of  the  capital,  or  $8,000,  plus 
$6,000  specific  deduction,  a  total  of  $14,000. 

The  amount  of  the  net  income  taxable  at  each  rate  will  be  as  follows: 


702  INCOME    AND    FEDERAL    TAX    REPORTS 

In  excess  of  the  deduction  and  not  in  excess  of  15  per  cent  of 

the  capital  (rate,  20  per  cent)    $1,000 

In  excess  of  15  per  cent  of  the  capital  and  not  in  excess  of  20  per 

cent  thereof   (rate,  25  per  cent) 5,000 

In  excess  of  20  per  cent  of  the  capital  and  not  in  excess  of  25 

per  cent  thereof   (rate,  35  per  cent)    2,500 

The  tax  would  then  be  computed  as  follows: 

20  per  cent  of  $1,000 $200 

25  per  cent  of  $5,000 1,250 

35  per  cent  of  $2,500 875 

Total  tax   $2,325 

17.  When  deduction  exceeds  15  per  cent  of  invested  capital. — In  any 
case  in  which  the  deduction  determined  as  provided  in  articles  21,  23 
and  24  is  greater  than  15  per  cent  of  the  invested  capital  and  therefore 
cannot  be  fully  allowed  under  the  first  rate  or  bracket  of  article  16, 
then  any  remaining  portion  of  the  deduction  will  be  allowed  under  the 
second  bracket,  and  continued  if  necessary  into  the  succeeding  bracket 
or  brackets  until  the  entire  amount  of  the  deduction  is  allowed. 

Illustrations. — (1)    A    corporation    has    a    capital    of    $9,000;    pre-war 
earnings  of  9  per  cent;  and  a  net  income  for  the  taxable  year  of  $10,000. 
The  deduction  allowed  will  be  9  per  cent  of  the  capital,  or  $810,  plus 
$3,000  specific  deduction,  a  total  of  $3,810. 

The  amount  of  the  net  income  in  each  bracket  will  be  as  follows: 

15  per  cent  of  the  capital $1,350 

In  excess  of  15  per  cent  of  the  capital  and  not  in  excess  of  20 

per  cent  thereof  450 

In  excess  of  20  per  cent  of  the  capital  and  not  in  excess  of  25  per 

cent   thereof    450 

In  excess  of  25  per  cent  of  the  capital  and  not  in  excess  of  33 

per  cent  thereof  720 

In  excess  of  33  per  cent  of  the  capital 7,030 

It  is  evident  that  the  total  deduction  of  $3,810  is  greater  than  15  per 
cent  of  the  capital  and  so  is  not  fully  absorbed  by  the  amount  of  net 
income  not  in  excess  of  15  per  cent  of  the  capital.    In  such  case,  apply- 
ing article  17,  the  total  deduction  of  $3,810  will  be  distributed  as  follows: 
$1,350  in  the  first  bracket,  leaving  nothing  to  be  taxed  at  the  20 

per  cent  rate. 
$450  in  the  second  bracket,  leaving  nothing  to  be  taxed  at  the  25 

per  cent  rate. 
$450  in  the  third  bracket,  leaving  nothing  to  be  taxed  at  the  35  per 

cent  rate. 
$720  in  the  fourth  bracket,  leaving  nothing  to  be  taxed  at  the  45  per 
cent  rate. 
There  still  remains  $840  of  the  deduction  to  be  allowed  in  the  fifth 
bracket  against  the  $7,030  of  income  which  would  otherwise  be  taxable 
under  that  bracket.     There  would  then  be  $6,190  of  net  income  left  to 
be  taxed  at  the  60  per  cent  rate  under  the  fifth  bracket.     Hence,  the 
total  excess  profits  tax  in  this  case  would  be  $3,714. 

(2)    An  individual  or  partnership  has   a  capital   of  $40,000,   pre-war 
earnings  of  9  per  cent,  and  a  net  income  for  the  taxable  year  of  $12,000. 
The  deduction  allowed  will  be  9  per  cent  of  the  capital,  or  $3,600,  plus 
$6,000  specific  deduction,  a  total  of  $9,600. 

The  amount  of  the  net  income  in  each  bracket  will  be  as  follows: 


WAR    EXCESS    PROFITS    TAX  703 

15  per  cent  of  the  capital  $6,000 

In  excess  of  15  per  cent  of  the  capital  and  not  in  excess  of  20 

per  cent  thereof  2,000 

In  excess  of  20  per  cent  of  the  capital  and  not  in  excess  of  25  per 

cent  thereof  2,000 

In  excess  of  25  per  cent  of  the  capital  and  not  in  excess  of  33 

per  cent  thereof   2,000 

It  is  evident  that  the  total  deduction  of  $9,600  is  greater  than  15  per 
cent  of  the  capital  and  so  is  not  fully  absorbed  by  the  amount  of  net  in- 
come not  in  excess  of  15  per  cent  of  the  capital.     In  such  case,  applying 
article  17,  the  total  deduction  of  $9,600  will  be  distributed  as  follows: 
$6,000  in  the  first  bracket,  leaving  nothing  to'  be  taxed  at  the  20 

per  cent  rate. 
$2,000  in  the  second  bracket,  leaving  nothing  to  be  taxed  at  the  25 

per  cent  rate. 
$1,600,  the  balance  of  the  deduction,  to  be  allowed  against  the  $2,000 
of  income  in  the  third  bracket. 
There  would  then  be  $400  of  income  left  in  the  third  bracket  to  be 
taxed  at  the  35  per  cent  rate,  and  $2,000  in  the  fourth  bracket  to  be 
taxed  at  the  45  per  cent  rate.    Hence,  the  total  excess  profits  tax  in  this 
case  would  be  $1,040. 

18.  Constructive  capital  for  application  of  rates. — Where  the  deduc- 
tion allowed  to  a  taxpayer  is  determined  under  article  24,  the  invested 
capital  for  the  purpose  of  applying  the  rates  of  taxation  under  article 

16  shall  be  deemed  to  be  an  amount  which  bears  the  same  ratio  to  the 
net  income  of  the  trade  or  business  for  the  taxable  year  which  the  aver- 
age invested  capital  for  the  corresponding  calendar  year  of  representa- 
tive corporations,  partnerships  and  individuals  engaged  in  a  like  or 
similar  trade  or  business  bears  to  their  average  net  income. 

The  Commissioner  of  Internal  Revenue  in  determining  for  any  calen- 
dar year  the  ratio  which  the  average  invested  capital  of  representative 
corporations,  partnerships  and  individuals  engaged  in  any  particular 
trade  or  business  bears  to  their  average  net  income,  will  include  the 
invested  capital  and  net  income  of  representative  corporations  and  part- 
nerships for  fiscal  years  ending  during  such  calendar  year. 

For  the  purpose  of  applying  this  article  in  the  case  of  a  corporation 
or  partnership  which  has  fixed  its  own  fiscal  year,  the  ratio  determined 
for  the  calendar  year  ending  during  such  fiscal  year  shall  be  used. 

19.  Computation  of  tax  for  fiscal  year,  part  of  which  falls  within  cal- 
endar year  1916. — If  a  corporation  or  partnership  prior  to  March  1, 
1918,  makes  a  return  for  a  fiscal  year,  part  of  which  falls  within  the  cal- 
endar year  1916,  the  tax  for  the  first  taxable  year  shall  be  that  pro- 
portion of  the  tax  computed  upon  the  net  income  for  such  fiscal  year 
which  the  number  of  months  from  January  1,  1917,  to  the  end  of  such 
fiscal  year  bears  to  the  entire  number  of  months  in  such  fiscal  year. 

20.  Computation  of  tax  for  period  of  less  than  12  months. — If  a  cor- 
poration or  partnership  at  any  time,  either  because  it  has  just  designated 
a  fiscal  year  as  provided  in  sections  8  or  13  of  the  act  of  September 
8,  1916  (see  Income  Tax  Regulations,  arts.  31  and  211),  or  for  any  other 
reason,  makes  a  return  for  a  period  of  less  than  12  months,  the  deduc- 
tion will  be  an  amount  which  bears  the  same  ratio  to  the  deduction 
allowable  for  a  full  year  as  the  number  of  months  in  such  period  bears 
to  12  months. 

COMPUTATION   OF   THE   DEDUCTION 

21.  Trade  or  business  having  invested  capital. — The  deduction  used 
in  computing  the  rates  of  tax  under  article  16  shall,  except  in  cases 
coming  within  the  conditions  specified  in  articles  23  and  24,  be  as  follows: 

(a)  In  the  case  of  a  domestic  corporation  the  sum  of  (1)  an  amount 


704.         INCOME    AND    FEDERAL    TAX    REPORTS 

equal  to  the  same  percentage  of  the  invested  capital  for  the  taxable 
year  which  the  average  amount  of  the  annual  net  income  of  the  trade 
or  business  during  the  pre-war  period  was  of  the  invested  capital  for 
the  pre-war  period  (except  that  7  per  cent  shall  be  used  if  such  per- 
centage was  less  than  7  per  cent,  and  9  per  cent  shall  be  used  if  such 
percentage  was  more  than  9  per  cent,  and  8  per  cent  shall  be  used  if  the 
corporation  was  not  in  existence  during  the  whole  of  at  least  one  calen- 
dar year  during  the  pre-war  period),  and  (2)  $3,000. 

(b)  In  the  case  of  a  domestic  partnership  or  of  a  citizen  or  resident 
of  the  United  States,  the  sum  of  (1)  an  amount  equal  to  the  same  per- 
centage of  the  invested  capital  for  the  taxable  year  which  the  average 
amount  of  the  annual  net  income  of  the  trade  or  business  during  the 
pre-war  period  was  of  the  invested  capital  for  the  pre-war  period  (ex- 
cept that  7  per  cent  shall  be  used  if  such  percentage  was  less  than  7 
per  cent,  and  9  per  cent  shall  be  used  if  such  percentage  was  more  than 
9  per  cent,  and  8  per  cent  shall  be  used  if  the  partnership  was  not  in 
existence  or  the  individual  was  not  engaged  in  the  trade  or  business 
during  the  whole  of  at  least  one  calendar  year  during  the  pre-war 
period),  and  (2)  $6,000. 

(c)  In  the  case  of  a  foreign  corporation  or  partnership  or  of  a  non- 
resident alien  individual,  an  amount  equal  to  the  same  percentage  of  the 
invested  capital  for  the  taxable  year  which  the  average  amount  of  the 
annual  net  income  of  the  trade  or  business  during  the  pre-war  period 
was  of  the  invested  capital  for  the  pre-war  period  (except  that  7  per 
cent  shall  be  used  if  such  percentage  was  less  than  7  per  cent,  and  9 
per  cent  shall  be  used  if  such  percentage  was  more  than  9  per  cent,  and 
8  per  cent  shall  be  used  if  the  corporation  or  partnership  was  not  in 
existence  or  the  individual  was  not  engaged  in  the  trade  or  business  dur- 
ing the  whole  of  at  least  one  calendar  year  during  the  pre-war  period) 

22.  Trade  or  business  reorganized  on  or  after  January  2,  1913. — If  a 
trade  or  business  carried  on  by  a  corporation,  partnership  or  individual 
was  formerly  organized  or  reorganized  on  or  after  January  2,  1913,  but 
is  substantially  a  continuation  of  a  trade  or  business  carried  on  prior 
to  that  date,  then  the  corporation  or  partnership  shall  be  deemed  to  have 
been  in  existence,  or  the  individual  shall  be  deemed  to  have  been  en- 
gaged in  the  trade  or  business,  prior  to  that  date,  and  for  the  purpose 
of  computing  the  deduction  the  net  income  and  invested  capital  of  the 
predecessor  shall  be  deemed  to  have  been  the  net  income  and  invested 
capital  of  the  present  owner  for  the  pre-war  period. 

23.  When  income  for  pre-war  period  cannot  be  satisfactorily  deter- 
mined, or  when  net  income  was  low  during  pre-war  period,  or  when  there 
was  no  net  income  during  pre-war  period. — In  the  following  cases  the 
deduction  shall  be  determined  as  provided  in  this  article: 

(a)  If  the  Secretary  of  the  Treasury  is  unable  satisfactorily  to  deter- 
mine the  average  amount  of  annual  net  income  of  the  trade  or  business 
for  the  pre-war  period; 

(b)  If  the  Secretary  of  the  Treasury  upon  complaint  finds  that  during 
the  pre-war  period  the  percentage  of  the  net  income  to  the  invested  cap- 
ital of  the  taxpayer  was  lower  by  one  per  cent  or  more  than  the  per- 
centage of  the  net  income  to  the  invested  capital  of  representative  cor- 
porations, partnerships  or  individuals  engaged  in  a  like  or  similar  trade 
or  business  during  the  same  period. 

(c)  If,  in  the  case  only  of  a  domestic  corporation  or  partnership  which 
was  in  existence  during  the  pre-war  period,  or  of  a  citizen  or  resident  of 
the  United  States  who  was  engaged  in  the  trade  or  business  during  the 
pre-war  period,  the  Secretary  of  the  Treasury  upon  complaint  finds  that 
during  the  pre-war  period  there  was  no  net  income  from  the  trade  or 
business. 

Jn  such  cases  the  deduction  shall  be — 

(1)  An  amount  equal  to  the  same  percentage  of  the  invested  capital 


WAR   EXCESS    PROFITS    TAX  705 

for  the  taxable  year  which  the  average  deduction  (determined  in  the 
same  manner  as  provided  in  article  21,  without  including  the  $3,000  or 
$6,000  therein  referred  to)  for  such  year  of  representative  corporations, 
partnerships  or  individuals  engaged  in  a  like  or  similar  trade  or  busi- 
ness, is  of  their  average  invested  capital  for  such  year,  plus 

(2)  In  the  case  of  a  domestic  corporation,  $3,000,  and  in  the  case  of  a 
domestic  partnership  or  a  citizen  or  resident  of  the  United  States,  $6,000. 

In  cases  arising  under  subdivision  (a)  or  (c)  of  this  article  the  tax 
shall  be  assessed  in  the  first  instance  upon  the  basis  of  a  deduction  com- 
puted by  the  use  of  7  per  cent.  In  cases  arising  under  subdivision  (b) 
the  tax  shall  be  assessed  in  the  first  instance  upon  the  basis  of  a  deduc- 
tion determined  as  provided  in  article  21. 

In  any  case  under  this  article  a  taxpayer  claiming  the  benefit  of  this 
provision  shall  at  the  time  of  making  the  return  file  a  claim  for  abate- 
ment (Form  47)  of  the  amount  by  which  the  tax  so  assessed  exceeds  a 
tax  computed  upon  the  basis  of  the  deduction  determined  as  provided 
in  this  article.  In  cases  coming  within  the  provisions  of  this  article 
payment  of  that  portion  of  the  tax  covered  by  the  claim  for  abatement 
will  not  be  required  until  the  claim  is  decided.  If,  however,  in  the 
judgment  of  the  Commissioner  of  Internal  Eevenue,  the  interests  of 
the  United  States  would  be  jeopardized  thereby,  the  right  is  reserved  to 
require  the  claimant  to  give  a  bond  of  such  amount  and  with  such 
sureties  as  the  commissioner  thinks  wise  to  safeguard  such  interests. 
The  bond  shall  be  conditioned  for  the  payment  of  any  tax  found  to  be 
due  with  interest  thereon,  and  if  a  bond  satisfactory  to  the  commis- 
sioner is  not  given  within  such  time  as  he  prescribes,  the  full  amount 
of  the  tax  assessed  will  become,  immediately  due  and  the  amount  over- 
paid, if  any,  will,  upon  final  decision  of  the  application,  be  refunded  as 
a  tax  erroneously  or  illegally  collected. 

24.  When  invested  capital  cannot  be  satisfactorily  determined. — If 
the  Secretary  of  the  Treasury  is  unable  satisfactorily  to  determine  the 
invested  capital,  the  deduction  shall  be  the  sum  of — 

(1)  An  amount  equal  to  the  same  proportion  of  the  net  income  of 
the  trade  or  business  for  the  taxable  year  as  the  average  deduction  (de- 
termined in  the  same  manner  as  provided  in  article  21  without  includ- 
ing the  $3,000  or  $6,000  therein  referred  to)  for  the  corresponding  cal- 
endar year,  of  representative  corporations,  partnerships  and  individuals 
engaged  in  a  like  or  similar  trade  or  business,  is  of  their  average  net 
income,  plus 

(2)  In  the  case  of  a  domestic  corporation,  $3,000,  and  in  the  case  of  a 
domestic  partnership  or  a  citizen  or  resident  of  the  United  States,  $6,000. 

The  Commissioner  of  Internal  Eevenue  in  determining  for  any  calen- 
dar year  the  proportion  which  the  average  deduction  of  representative 
corporations,  partnerships  and  individuals  engaged  in  any  particular 
trade  or  business  is  of  their  average  net  income,  will  include  the  deduc- 
tions and  net  income  of  representative  corporations  and  partnerships 
for  fiscal  years  ending  during  such  calendar  year. 

For  the  purpose  of  applying  this  article  in  the  case  of  a  corporation 
or  partnership  which  has  fixed  its  own  fiscal  year,  the  proportion  deter- 
mined for  the  calendar  year  ending  during  such  fiscal  year  shall  be  used. 

In  every  case  of  a  trade  or  business  having  invested  capital  a  return 
shall  be  made  in  the  first  instance  in  accordance  with  article  21  or  23, 
but  the  taxpayer  may  submit  therewith  a  statement  of  reasons  why  in 
his  opinion  the  tax  should  be  assessed  in  accordance  with  this  article. 

NET   INCOME— GENERAL   PROVISIONS 

25.  Exemptions. — The  following  classes  of  income  are  exempt  from 
the  tax: 

(a)  Income  exempt  from  taxation  under  section  4  of  the  act  of  Sep- 
tember 8,  1916,  as  amended.     (See  Income  Tax  Eegulations,  art.  5.) 


706  INCOME   AND   FEDERAL    TAX   REPORTS 

(b)  Income  derived  from  the  business  of  life,  health,  and  accident  in- 
surance combined  in  one  policy  issued  on  a  weekly  premium  payment 
plan. 

(c)  Compensation  or  fees  received  by  officers  and  employees  under  the 
United  States  or  any  State,  Territory  or  the  District  of  Columbia  for 
their  services  as  such. 

26.  Net  income  of  foreign  corporations,  partnerships  and  non-resident 
alien  individuals. — In  the  case  of  a  foreign  corporation  or  partnership 
or  a  non-resident  alien  individual  the  net  income  shall  be  the  net  income 
from  sources  within  the  United  States. 

27.  Dividends  received  from  a  foreign  "corporation  which  is  subject  to 
Federal  income  tax. — In  the  case  of  income  derived  by  a  corporation  or 
partnership  from  dividends  upon  the  stock  of  a  foreign  corporation,  part 
of  whose  net  income  is  subject  to  the  income  tax,  there  shall  be  deducted 
only  that  proportion  of  the  dividends  received  upon  such  stock  which 
the  net  income  of  such  foreign  corporation  from  sources  within  the 
United  States  is  of  its  entire  net  income. 

Where  dividends  upon  the  stock  of  a  foreign  corporation  are  received 
by  an  individual,  as  a  part  of  his  income  from  trade  or  business,  there 
shall  be  included  in  the  net  income  that  proportion  of  the  dividends  re- 
ceived upon  such  stock  which  the  net  income  of  such  corporation  from 
sources  outside  the  United  States  is  of  its  entire  net  income. 

NET   INCOME— CORPORATIONS 

28.  Taxable  year. — The  net  income  of  a  corporation  for  the  taxable 
year  shall  be  determined  by  adding  (1)  the  amount  of  net  income  ascer- 
tained and  returned  for  income  tax  purposes  for  such  taxable  year  as 
provided  in  Title  I  of  the  act  of  September  8,  1916,  as  amended,  and  (2) 
the  amount,  if  any,  received  as  interest  on  bonds  or  other  obligations 
of  the  United  States,  issued  after  September  24,  1917  (other  than  the  in- 
terest received  on  an  amount  of  such  bonds  or  obligations  the  aggregate 
principal  of  which  does  not  exceed  $5,000),  and  deducting  from  the 
total  so  obtained  the  amounts  received  during  the  taxable  year  as  divi- 
dends upon  the  stock  or  from  the  net  earnings  of  other  corporations, 
joint-stock  companies  or  associations,  or  insurance  companies,  subject  to 
the  income  tax  imposed  by  Title  I  of  such  act  of  September  8,  1916,  as 
amended,  except  as  otherwise  provided  in  article  27. 

29.  Pre-war  period. — The  net  income  of  a  corporation  for  the  pre-war 
period  shall  be  computed  as  follows: 

(a)  For  the  calendar  year  1911  by  adding  (1)  the  amount  of  net  in- 
come shown  in  item  9  of  the  return  made  under  section  38  of  the  act  of 
August  5,  1909,  for  the  calendar  year  1911,  and  (2)  the  amount  of  taxes 
paid  to  the  United  States  within  the  calendar  year  1911  under  section  38 
of  such  act; 

(b)  For  the  calendar  year  1912  by  adding  (1)  the  amount  of  net  in- 
come shown  in  item  9  of  the  return  made  under  section  38  of  the  act  of 
August  5.  1909,  for  the  calendar  year  1912,  and  (2)  the  amount  of  taxes 
paid  to  the  United  States  within  the  calendar  year  1912  under  section 
38  of  such  act;  and 

(c)  For  the  calendar  year  1913  by  adding  (1)  the  amount  of  the  en- 
tire net  income  shown  in  item  8  of  the  return  made  under  Section  II 
of  the  act  of  October  3,  1913,  for  the  calendar  year  1913,  and  (2)  the 
amount  of  taxes  paid  within  the  calendar  year  1913  under  section  38 
of  the  act  of  August  5.  1909,  and  Section  II  or  IV  of  the  act  of  Oc- 
tober 3,  1913,  and  deducting  from  the  total  so  obtained  the  amounts  re- 
ceived during  the  calendar  year  1913  as  dividends  upon  the  stock  or  from 
the  net  earnings  of  other  corporations,  joint-stock  companies  or  associa- 
tions, or  insurance  companies,  subject  to  the  income  tax  imposed  by  Sec- 
tion II  of  the  act  of  October  3,  1913. 


WAR   EXCE88   PROFITS    TAX  707 

NET    INCOME— PARTNERSHIPS 

30.  Taxable  year. — The  net  income  of  a  partnership  for  the  taxable 
year  shall  be  determined  by  adding  the  amount  of  its  entire  net  income 
(or  in  the  case  of  a  foreign  partnership,  its  entire  net  income  from 
sources  within  the  United  States)  ascertained  upon  the  same  basis  and 
in  the  same  manner  as  provided  with  respect  to  individuals  for  income- 
tax  purposes  by  Title  I  of  the  act  of  September  8,  1916,  as  amended 
(see  Income  Tax  Regulations,  art.  30),  including  the  amounts,  if  any, 
received  during  the  year  as  interest  on  bonds  or  other  obligations  of  the 
United  States  issued  after  September  24,  1917  (other  than  the  interest 
on  an  amount  of  such  bonds  or  obligations,  the  aggregate  principal  of 
which  does  not  exceed  $5,000),  and  deducting  therefrom — 

(1)  The  amounts  received  during  the  taxable  year  as  dividends  upon 
the  stock  or  from  the  net  earnings  of  corporations,  joint-stock  companies 
or  associations,  or  insurance  companies,  subject  to  the  income  tax  imposed 
by  Title  I  of  the  act  of  September  8,  1916,  as  amended,  except  as  other- 
wise provided  in  article  27;  and 

(2)  The  deductions,  if  any,  for  salaries  or  interest  allowed  by  articles 
32  and  33,  if  such  deductions  have  not  already  been  made. 

31.  Pre-war  period. — The  net  income  of  a  partnership  for  each  of  the 
calendar  years  1911,  1912  and  1913  shall  be  determined  in  the  same 
manner  as  the  net  income  for  the  taxable  year,  except  that  dividends 
upon  the  stock  or  from  the  net  earnings  of  corporations,  joint-stock  com- 
panies or  associations,  or  insurance  companies,  subject  to  the  tax  imposed 
by  section  38  of  the  act  of  August  5,  1909,  or  by  Section  II  of  the  act  of 
October  3,  1913,  shall  be  deducted.     (See  art.  30.) 

32.  Deductions  allowed  for  salaries  paid  to  partners. — In  computing 
net  income  for  purposes  of  the  excess  profits  tax  a  partnership  will  be 
allowed  to  deduct  as  an  expense  reasonable  salaries  or  compensation  paid 
to  individual  partners  for  personal  services  actually  rendered  during  the 
taxable  year,  if  the  payments  are  made  in  accordance  with  prior  agree- 
ments and  are  properly  recorded  on  the  books  of  the  partnership.  In  no 
case  shall  the  salaries  or  compensation  so  deducted  be  in  excess  of  the 
salaries  or  compensation  customarily  paid  for  similar  services  under  like 
responsibilities  by  corporations  engaged  in  like  or  similar  trades  or 
businesses. 

With  respect  to  any  period  prior  to  March  1,  1918,  regardless  of 
whether  a  previous  agreement  has  been  made  as  to  salaries  or  compen- 
sation, a  similar  deduction  will  be  allowed  for  services  actually  ren- 
dered. 

In  the  case  of  a  foreign  partnership  the  deduction  shall  be  limited  to 
those  portions  of  salaries  or  compensation  which  are  paid  for  services 
rendered  with  respect  to  trade  or  business  carried  on  in  the  United 
States. 

A  partner  in  his  individual  capacity  is,  however,  subject  to  the  excess 
profits  tax,  if  any,  at  the  8  per  cent  rate  under  article  15  with  respect 
to  any  salary  or  compensation  from  the  partnership  for  personal  services 
(including  any  amounts  allowed  to  the  partnership  as  a  deduction  on  his 
account  for  the  period  prior  to  March  1,  1918). 

33.  Deductions  allowed  for  interest  on  bona  fide  loans  by  partners  — 
In  computing  net  income  for  purposes  of  the  excess  profits  tax  a  part- 
nership will  be  allowed  to  deduct  amounts  paid  during  the  year  to  an 
individual  partner  as  interest  upon  any  bona  fide  loan,  but  no  deduction 
for  so-called  interest  upon  capital  will  be  allowed. 

34.  If  deduction  is  made  under  article  32  or  33,  corresponding  deduc- 
tion must  also  be  made  for  pre-war  period. — If,  in  computing  net  income 
for  purposes  of  the  excess  profits  tax,  a  partnership  makes  a  deduction 
as  allowed  by  article  32  for  salaries  paid  to  partners  during  the  taxable 
year,  it  must  also,  in  computing  net  income  for  the  pre-war  period,  make 


708  INCOME    AND    FEDERAL    TAX    REPORTS 

a  corresponding  deduction;  and  if  it  makes  such  a  deduction  as  allowed 
by  article  33  for  interest  paid  to  partners,  it  must  also,  in  computing  net 
income  for  the  pre-war  period,  make  a  corresponding  deduction  for  any- 
such  interest  actually  paid  during  that  period. 

NET   INCOME— INDIVIDUALS 

35.  Determination  of  net  income  where  there  is  no  invested  capital  or 
only  nominal  capital. — The  net  income  which  is  derived  from  a  trade  or 
business  having  no  invested  capital  or  not  more  than  a  nominal  capital, 
including  salaries,  wages,  fees  or  other  compensations  (constituting  net 
income  of  class  A  as  denned  in  art.  14)  shall  be  determined  for  the  tax- 
able year  by  adding  the  total  net  income  from  all  such  sources  (or  in 
the  case  of  a  non-resident  alien  individual  the  total  net  income  from  all 
such  sources  within  the  United  States)  as  reported  for  income  tax  pur- 
poses for  the  same  year. 

36.  Determination  of  net  income  for  taxable  year  when  there  is  in- 
vested capital. — The  net  income  which  is  derived  from  a  trade  or  busi- 
ness having  invested  capital  (constituting  net  income  of  class  B,  as  de- 
fined in  art.  14)  shall  be  determined  for  the  taxable  year  by  adding  the 
total  net  income  from  such  sources  (or  in  the  case  of  a  non-resident  alien 
individual  the  total  net  income  from  such  sources  within  the  United 
States)  as  reported  for  income  tax  purposes  for  the  same  year  and  de- 
ducting therefrom  the  deduction,  if  any,  for  salary  allowed  by  article  39, 
if  such  deduction  has  not  already  been  made. 

There  shall  be  excluded  the  amounts  received  during  the  year  upon  the 
stock  or  from  the  net  earnings  of  corporations,  joint-stock  companies  or 
associations,  or  insurance  companies,  subject  to  the  income  tax  imposed 
by  Title  I  of  the  act  of  September  8,  1916,  as  amended. 

In  the  case,  however,  of  an  individual  dealing  in  securities  or  other- 
wise using  securities  in  trade  or  business  there  shall  be  included  (1)  the 
amount,  if  any,  received  as  interest  on  bonds  or  obligations  of  the  United 
States,  issued  after  September  24,  1917  (other  than  the  interest  received 
on  an  amount  of  such  bonds  or  obligations  the  aggregate  principal  of 
which  does  not  exceed  $5,000),  and  (2)  such  proportion  of  dividends  re- 
ceived upon  the  stock  of  foreign  corporations  as  is  required  to  be  included 
by  article  27. 

Elustration. — An  individual  owns  a  farm  representing  an  invested  cap- 
ital of  $25,000,  a  country  store  with  an  invested  capital  of  $6,000,  and  a 
flour  mill  with  an  invested  capital  of  $10,000.  His  net  income  from  the 
farm  is  $4,000,  from  the  store  $3,000,  and  from  the  mill  $3,000.  Thus  his 
total  net  income  of  class  B  is  $10,000.  His  total  invested  capital  is 
$41,000.  Assuming  that  his  deduction  is  at  the  rate  of  8  per  cent,  his 
total  deduction  will  be  $3,280  plus  $6,000,  or  $9,280,  to  be  applied  against 
his  net  income  of  $10,000  in  computing  the  tax  at  the  graduated  rates  un- 
der articles  16  and  17. 

The  same  individual  allows  himself  a  salary  of  $1,000  for  working  the 
farm  and  $900  for  running  the  store,  draws  a  salary  of  $1,200  as  presi- 
dent of  the  local  bank,  and  receives  $250  in  compensation  for  personal 
services  of  various  kinds,  such  as  road  work,  helping  neighbors  in  har- 
vest, etc.  He  also  receives  $300  in  dividends  on  an  investment  in  cer- 
tain stocks  and  $100  as  supervisor's  fees.  The  last  item — that  is,  super- 
visor's fees — is  exempt  under  the  law  (sec.  201,  subdivision  a).  The 
$300  in  dividends  is  not  taxable,  inasmuch  as  it  is  derived  from  a  mere 
investment  not  connected  with  his  trade  or  business.  His  net  income  of 
class  A  will  therefore  consist  of  his  salaries  and  his  compensation  for 
personal  services,  a  total  of  $3,350.  Since  he  is  entitled  to  a  deduction 
of  $6,000  as  to  this  class  of  income,  he  will  have  no  tax  to  pay  at  the  8 
per  cent  rate  under  article  15. 

37.  Deduction  of  contributions  for  religious,  charitable,  etc.,  purposes. 


WAR   EXCESS   PROFITS    TAX  709 

— Contributions  or  gifts  for  religious,  charitable,  etc.,  purposes  allowed 
as  a  deduction  for  purposes  of  the  income  tax  under  paragraph  "Ninth" 
of  subdivision  (a)  of  section  5  of  the  act  of  September  8,  1916,  as 
amended,  may,  subject  to  the  limitations  therein  contained,  be  deducted 
in  computing  the  net  income  of  the  trade  or  business  for  purposes  of  the 
excess  profits  tax  only  when  it  is  shown  to  the  satisfaction  of  the  Com- 
missioner of  Internal  Revenue  that  such  contributions  or  gifts  are  made 
by  the  trade  or  business  and  not  by  the  individual  in  his  personal  ca- 
pacity. 

38.  Determination  of  net  income  for  the  pre-war  period  where  there  is 
invested  capital. — The  net  income  which  is  derived  from  a  trade  or  busi- 
ness having  invested  capital  (constituting  net  income  of  class  B  as  de- 
fined in  article  14)  shall  be  determined  for  each  of  the  calendar  years 
1911,  1912  and  1913  upon  the  same  basis  and  in  the  same  manner  as  pro- 
vided in  article  36. 

39.  Deduction  allowed  for  salary  to  himself. — An  individual  carrying 
on  a  trade  or  business  having  an  invested  capital  may,  in  computing  the 
net  income  of  the  trade  or  business  for  purposes  of  the  excess  profits  tax, 
deduct  a  reasonable  amount  designated  by  him  as  salary  or  compensa- 
tion for  personal  service  actually  rendered  by  him  in  the  conduct  of 
such  trade  or  business.  In  no  case  shall  the  amount  so  designated  be  in 
excess  of  the  salaries  or  compensation  customarily  paid  for  similar  serv- 
ice under  like  responsibilities  by  corporations  or  partnerships  engaged  in 
like  or  similar  trades  or  businesses. 

In  the  case  of  a  non-resident  alien  individual,  the  amount  deducted 
shall  be  limited  to  that  portion  of  the  salary  or  compensation  which  is 
for  service  rendered  with  respect  to  trade  or  business  carried  on  in  the 
United  States. 

The  amount  so  designated  shall,  however,  be  included  in  computing  his 
net  income  of  class  A  under  article  35;  and  the  balance  of  the  income 
from  his  trade  or  business  shall  be  included  in  computing  his  net  income 
of  class  B  under  article  36. 

Illustration. — An  individual  owns  and  runs  a  newspaper  having  an  in- 
vested capital  of  $50,000.  The  net  income  from  the  newspaper,  without 
making  any  allowance  for  the  salary  of  the  owner,  is  $20,000,  and,  as 
income  of  class  B,  is  subject  to  the  graduated  rates  prescribed  in  article 
16.  His  deduction,  as  provided  for  in  subdivision  (b)  of  article  21,  would 
be  $4,500  (9  per  cent  of  his  capital),  plus  $6,000,  a  total  of  $10,500.  If, 
however,  he  allows  himself  a  salary  of  $3,000,  the  net  income  from  the 
newspaper  will  be  $17,000,  and  the  deduction  of  $10,500  will  be  applied 
against  that  amount. 

His  salary  of  $3,000  must  be  included  in  his  return  as  income  of  class 
A,  which  is  subject  to  the  8  per  cent  rate  under  article  15.  If  it  consti- 
tutes his  only  income  of  that  class  he  will  pay  no  tax  thereon,  inasmuch 
as  it  is  less  than  the  deduction  of  $6,000  to  which  he  is  entitled  as  to 
that  class  of  income.  But  if,  for  example,  he  receives  in  addition  a  sal- 
ary of  $4,000  as  president  of  the  local  bank,  his  total  net  income  of  class 
A  will  be  $7,000,  and  he  will  be  required  to  pay  a  tax  of  8  per  cent  on 
$1,000  thereof,  or  $80. 

40.  If  deduction  is  made  under  article  39  corresponding  deduction  must 
also  be  made  for  pre-war  period. — If,  in  computing  net  income  for  pur- 
poses of  the  excess  profits  tax,  an  individual  deducts  a  reasonable  amount 
designated  as  salary  or  compensation  for  personal  services  rendered  by 
himself,  as  allowed  by  article  39,  he  must  also,  in  computing  net  income 
for  the  pre-war  period,  make  a  corresponding  deduction. 

41.  Individual  member  of  partnership. — Inasmuch  as  a  partner  in  his 
individual  capacity  is  not  considered  to  be  engaged  in  trade  or  business 
with  respect  to  his  share  in  the  profits  of  the  partnership,  he  is  not  sub- 
ject to  excess  profits  tax  thereon.     Consequently,  in  computing  his  net 


710  INCOME    AND    FEDERAL    TAX   REPORTS 

income  for  purposes  of  the  excess  profits  tax,  he  need  not  include  his 
share  of  the  partnership  profits. 

He  shall,  however,  in  computing  his  net  income  of  class  A  under 
article  35,  include  any  salary  or  compensation  from  the  partnership  for 
personal  services  (including  any  amount  allowed  to  the  partnership  as  a 
deduction  on  his  account  for  the  period  prior  to  March  1,  1918,  in  accord- 
ance with  article  32). 

INVESTED   CAPITAL— GENERAL    PROVISIONS 

42.  Allowance  for  depletion,  depreciation,  and  obsolescence  in  compu- 
tation of  invested  capital. — The  term  "invested  capital"  as  used  in  the 
excess  profits  tax  law  means  the  invested  capital  of  the  present  owner. 
The  basis,  or  starting  point,  in  the  computation  of  invested  capital  is 
found  in  the  amount  of  cash  and  other  property  paid  in,  the  original 
values  of  such  other  property  being  determined  in  accordance  with  the 
rules  laid  down  in  these  regulations.  But  the  computation  does  not  stop 
with  such  original  entries  or  amounts;  it  must  take  properly  into  ac- 
count the  surplus  and  undivided  profits.  In  the  computation  of  surplus 
and  undivided  profits,  however,  full  recognition  must  first  be  given  to 
expenses  incurred  and  losses  sustained  from  the  original  organization  of 
the  business  concern  down  to  the  taxable  year,  including  among  such  ex- 
penses and  losses  a  reasonable  allowance  for  depletion,  depreciation, 
or  obsolescence  of  property  originally  acquired  for  cash  or  for  stock  or 
shares  or  in  any  other  manner.  If  value  appreciation  of  a  kind  not 
subject  to  income  tax  (other  than  that  allowed  under  article  55)  has  been 
taken  up  in  the  accounts,  a  deduction  must  be  made  in  respect  of  such 
appreciation  so  taken  up.  In  the  computation  of  the  invested  capital  for 
any  year  full  effect  must  also  be  given  to  any  liquidation  of  the  original 
capital. 

43.  How  to  ascertain  average  invested  capital  for  the  year,  averaged 
monthly. — The  invested  capital  for  any  pre-war  or  taxable  year  (or 
where  the  tax  is  computed  upon  the  basis  of  a  period  less  than  a  year, 
for  such  period)  is  the  average  invested  capital  for  the  year  or  period 
averaged  monthly,  according  to  the  following  rules: 

(a)  Add  the  capital  for  each  of  the  several  months  during  which  no 
change  occurs,  and  the  average  capital  (ascertained  as  provided  in  sub- 
division (b)  of  this  article)  for  each  month  in  which  a  change  occurs 
and  divide  the  total  by  the  number  of  months  in  the  year  or  period. 

(b)  To  ascertain  the  capital  for  any  month  in  which  a  change  occurs 
multiply  the  capital  as  of  the  first  day  of  the  month  by  the  number  of 
days  it  remains  constant  and  the  capital  after  each  change  by  the  num- 
ber of  days  (including  the  day  on  which  the  change  occurs)  during  which 
it  remains  constant,  add  the  products,  and  divide  the  sum  by  the  number 
of  days  in  the  month. 

44.  Items  not  allowed  to  be  included  in  invested  capital. — The  second 
paragraph  of  section  207  of  the  excess  profits  law  specifies  certain  items 
which  may  not  be  included  in  invested  capital,  namely: 

(a)  Stocks,  bonds  (other  than  obligations  of  the  United  States),  or 
other  assets,  the  income  from  which  is  not  subject  to  the  excess  profits 
tax;  and 

(b)  Money  or  other  property  borrowed. 

The  term  "money  or  other  property  borrowed"  as  used  in  section 
207  and  these  regulations  includes  not  only  cash  or  other  borrowed  prop- 
erty which  can  be  identified  as  such,  but  current  liabilities  and  tem- 
porary indebtedness  of  all  kinds,  and  any  permanent  indebtedness  upon 
which  the  taxpayer  is  entitled  to  an  interest  deduction  in  computing  net 
income.  A  corporation  which  under  the  income-tax  law  is  allowed  to 
deduct  only  a  part  of  the  entire  interest  paid  upon  its  indebtedness,  may 
include  in  its  invested  capital  such  a  proportion  of  its  permanent  indebt- 


WAR   EXCESS   PROFITS    TAX  7U 

edness  as  the  amount  of  interest  upon  such  indebtedness  which  the  cor- 
poration is  not  allowed  to  deduct  is  of  the  total  amount  of  interest  paid 
upon  such  indebtedness  during  the  taxable  year. 

45.  When  income  from  tax-free  securities  consists  partly  of  trading 
profits  and  partly  of  interest,  dividends,  etc. — Whenever  income  consists 
partly  of  gains  or  profits  subject  to  the  excess  profits  tax  arising  from 
trading  in  stocks,  bonds,  etc.,  the  dividends  or  interest  on  which  are  not 
subject  to  such  tax,  and  partly  of  such  dividends  or  interest,  then,  sub- 
ject to  the  limitations  as  to  borrowed  money,  there  shall  be  included  in 
the  invested  capital  an  amount  which  bears  the  same  ratio  to  the  total 
amount  invested  in  such  stocks  or  bonds  as  the  amount  of  such  gains  or 
profits  bears  to  the  total  amount  of  such  income. 

46.  Treatment  of  stock  of  foreign  corporations  when  held  by  domes- 
tic corporations  or  partnerships  or  by  citizens  or  residents  of  the  United 
States. — In  the  case  of  domestic  corporations  or  partnerships  and  of  citi- 
zens or  residents  of  the  United  States  holding  stock  in  a  foreign  cor- 
poration part  of  whose  net  income  is  subject  to  the  income  tax,  there 
shall  be  included  in  invested  capital  such  proportion  of  the  value  of  the 
stock  in  such  foreign  corporation  as  the  net  income  of  such  foreign  cor- 
poration from  sources  outside  the  United  States  is  of  its  entire  net  income. 

47.  Construction  of  terms  "tangible  property"  and  "intangible  prop- 
erty."— The  term  "other  intangible  property"  as  used  in  section  207 
will  be  construed  to  mean  property  of  a  character  similar  to  good  will, 
trade-marks,  and  the  other  specific  kinds  of  property  enumerated  in  the 
same  clause.  With  respect  to  property  not  clearly  of  such  a  character, 
rulings  will  be  issued  as  occasion  may  demand  to  indicate  whether  it 
shall  be  regarded  as  tangible  or  intangible. 

The  following  classes  of  property,  when  paid  in  for  stock  or  shares 
in  a  corporation  or  partnership,  will  be  regarded  as  tangible  property 
so  paid  in: 

(a)  Stocks. 

(b)  Bonds. 

(c)  Bills  and  accounts  receivable. 

(d)  Notes  and  other  evidences  of  indebtedness. 

(e)  Leaseholds. 

But  when  a  corporation  pays  for  intangible  property  by  the  issuance 
of  its  own  stock  or  bonds,  this  will  not  be  regarded  as  being  a  payment 
bona  fide  made  in  cash  or  tangible  property  within  the  meaning  of  sec- 
tion 207. 

48.  Invested  capital  of  foreign  corporations  or  partnerships  or  non- 
resident alien  individuals. — When  used  with  reference  to  a  foreign  corpo- 
ration or  partnership  or  a  non-resident  alien  individual,  the  term  "in- 
vested capital"  means  that  proportion  of  the  entire  invested  capital  as 
defined  and  limited  by  these  regulations  which  the  net  income  from 
sources  within  the  United  States  is  of  the  entire  net  income. 

49.  Reorganization  on  or  after  January  2,  1913. — A  trade  or  business 
carried  on  by  a  corporation,  partnership,  or  individual,  which  has  been 
formerly  organized  or  reorganized  on  or  after  January  2,  1913,  but  which 
is  substantially  a  continuation  of  a  trade  or  business  carried  on  prior 
to  that  date,  shall,  for  the  purposes  of  the  excess  profits  tax,  be  deemed 
to  have  been  in  existence  prior  to  that  date  and  the  invested  capital 
of  its  predecessor  prior  to  that  date  shall  be  deemed  to  have  been  its 
invested  capital.  This  article  relates  to  the  pre-war  period  and  does 
not  apply  to  the  invested  capital  for  the  taxable  year. 

50.  Reorganization  after  March  3,  1917. — In  case  of  the  reorganiza- 
tion, consolidation,  or  change  of  ownership  of  a  trade  or  business  after 
March  3,  1917,  if  an  interest  or  control  in  such  trade  or  business  of  50 
per  cent  or  more  remains  in  control  of  the  same  persons,  corporations, 
associations,  partnerships,  or  any  of  them,  then  in  ascertaining  the  in- 
vested capital  of  the  trade  or  business  no  asset  transferred  or  received 


712  INCOME   AND   FEDERAL    TAX   REPORTS 

from  the  prior  trade  or  business  shall  be  allowed  a  greater  value  than 
would  have  been  allowed  under  these  regulations  in  computing  the 
invested  capital  of  such  prior  trade  or  business  if  such  asset  had  not 
been  so  transferred  or  received,  unless  such  asset  was  paid  for  specifically 
as  such,  in  cash  or  tangible  property,  and  then  not  to  exceed  the  actual 
cash  or  actual  cash  value  of  the  tangible  property  paid  therefor  at  the 
time  of  such  payment. 

51.  Invested  capital  for  pre-war  period. — The  invested  capital  for  the 
pre-war  period  shall,  in  general,  be  determined  in  the  same  manner  as 
for  the  taxable  year,  except  that  the  valuation  as  of  January  1,  1914, 
shall  not  apply  to  tangible  property  paid  in  for  stock  or  shares. 

52.  Scope  of  section  210. — Section  210  provides  for  exceptional  cases 
in  which  the  invested  capital  can  not  be  satisfactorily  determined.  In 
such  cases  the  taxpayer  may  submit  to  the  Commissioner  of  Internal 
Revenue  evidence  in  support  of  a  claim  for  assessment  under  the  pro- 
visions of  section  210.  (See  articles  18  and  24.)  Such  exceptional  cases 
may  consist,  among  others,  of  the  following: 

(1)  Where,  through  defective  accounting  or  the  lack  of  adequate  data, 
it  is  impossible  accurately  to  compute  invested  capital. 

(2)  Where  upon  application  by  a  foreign  taxpayer  the  Secretary  of  the 
Treasury  finds  that  the  expense  of  securing  the  data  necessary  for  the 
computation  of  the  invested  capital  would  be  unreasonable  in  view  of  the 
amount  of  tax  involved,  or  that  it  is  impracticable  to  determine  either 
the  "entire  invested  capital"  or  the  "entire  net  income." 

(3)  Long-established  business  concerns  which  by  reason  of  ultra-con- 
servative accounting  or  the  form  and  manner  of  their  organization 
would,  through  the  operation  of  section  207,  be  placed  at  a  serious  dis- 
advantage in  competing  with  representative  concerns  in  a  like  or  similar 
trade  or  business. 

(4)  Where  the  invested  capital  is  seriously  disproportionate  to  the 
taxable  income.    Such  cases  may  arise  through: 

(a)  The  realization  in  one  year  of  the  earnings  of  capital  unproduc- 
tively  invested  through  a  period  of  years  or  of  the  fruits  of  activities 
antedating  the  taxable  year;  or, 

(b)  Inability  to  recognize  or  properly  allow  for  amortization,  obso- 
lescence, or  exceptional  depreciation  due  to  the  present  war,  or  to  the 
necessity  in  connection  with  the  present  war  of  providing  plant  which 
will  not  be  wanted  for  the  purposes  of  the  trade  or  business  after  the 
termination  of  the  war. 

INVESTED    CAPITAL— CORPORATIONS    AND    PARTNERSHIPS 

53.  Rule  for  computing  invested  capital. — In  computing  invested  cap- 
ital, every  corporation  or  partnership  paying  taxes  at  the  graduated  rates 
prescribed  in  section  201  (see  art.  16),  shall  add  together  its  paid  in 
capital  and  its  paid  in  or  earned  surplus  and  undivided  profits  (under 
whatever  name  the  same  may  be  called)  as  shown  by  its  books  at  the 
beginning  of  the  taxable  year.  The  total  thus  obtained  shall  be  ad- 
justed for  any  asset  or  item  which  it  covers  that  is  not  carried  on  the 
books  at  the  valuation  prescribed  by  law  or  by  these  regulations.  When 
necessary,  adjustment  (addition  or  subtraction)  shall  be  made  in  respect 
of  the  following: 

ADJUSTMENTS 

1.  Stock  or  shares  issued  in  the  purchase  of  intangible  property  prior 
to  March  3,  1917,  which  cannot  be  included  in  an  amount  exceeding  (a) 
20  per  cent  of  the  par  value  of  the  total  stock  or  shares  outstanding  on 
that  date,  (b)  the  actual  value  of  such  intangible  property  at  the  date 
acquired,  or  (c)  the  par  value  of  the  stock  or  shares  issued  in  payment 
therefor,  whichever  is  the  lowest.     (See  arts.  57  and  58.) 


WAR    EXCESS   PROFITS    TAX  713 

2.  Stock  or  shares  issued  for  a  mixed  aggregate  of  tangible  property, 
patents  and  copyrights,  and  good  will  or  other  intangible  property.  (See 
art.  59.) 

3.  Stock  or  shares  issued  for  patents  and  copyrights,  valued  at  (a) 
their  actual  cash  value  at  the  time  of  payment,  or  (b)  the  par  value  of 
the  stock  or  shares  issued  therefor,  whichever  is  lower.     (See  art.  56.) 

4.  Stock  or  shares  issued  for  tangible  property  prior  to  January  1, 
1914,  valued  at  (a)  the  actual  cash  value  of  such  property  on  January  1, 
1914,  or  (b)  the  par  value  of  the  stock,  whichever  is  the  lower.  (See 
art.  55.) 

5.  Stock  originally  issued  for  property  and  subsequently  returned  to 
the  corporation  as  a  gift,  etc.     (See  art.  54.) 

6.  Add  any  proportion  of  its  permanent  indebtedness  which  may  be 
included  under  article  44. 

7.  Add  value  of  tangible  property  paid  in  for  stock  or  shares  in  excess 
of  the  par  value  of  such  shares,  when  authorized  by  article  63. 

8.  Add  amounts  expended  in  the  past  for  (a)  the  acquisition  of  tan- 
gible property  or  (b)  specifically  for  good  will  and  other  similar  intan- 
gible property,  when  authorized  by  article  64. 

9.  For  the  valuation  of  assets  acquired  in  reorganizations,  etc.,  (a) 
effected  after  March  3,  1917,  see  article  50;  (b)  as  to  the  pre-war  period, 
see  articles  49  and  51. 

10.  Deduct  amounts  representing  appreciation  excluded  by  article  42. 

11.  Make  any  additional  deductions  required  by  reason  of  insufficient 
allowances  in  the  accounts  of  the  taxpayer  for  depletion,  depreciation 
and  obsolescence.     (See  art.  42.) 

Whenever  any  corrections  are  made  in  respect  of  the  capital  stock  and 
surplus,  corresponding  corrections  must  be  made  in  the  respective  asset 
items  in  the  balance  sheet  of  the  taxpayer. 

After  making  any  adjustments  required  under  paragraphs  1  to  11 
above,  the  adjusted  total  of  the  capital  and  surplus  account  will  repre- 
sent the  invested  capital  at  the  beginning  of  the  taxable  year,  except 
that  in  any  case  where  the  admissible  assets  (and  these  include  all  assets 
when  valued  in  accordance  with  these  regulations,  except  stocks,  bonds — 
other  than  obligations  of  the  United  States — the  income  of  which  is  not 
subject  to  excess  profits  tax)  are  less  than  the  amount  of  such  adjusted 
total,  then  the  invested  capital  must  be  further  reduced  to  an  amount 
equal  to  the  sum  of  the  admissible  assets.  Tax-free  securities  and  stock 
in  foreign  corporations  may  be  included  as  admissible  assets  to  the  extent 
authorized  in  articles  45  and  46. 

If  there  has  been  any  change  made  during  the  taxable  year  in  the 
amount  of  the  invested  capital,  the  monthly  average  shall  be  taken  (see 
art.  43),  but  in  no  case  may  the  invested  capital  include  any  surplus  or 
undivided  profits  earned  during  the  taxable  year. 

With  respect  to  the  taxable  year  1917,  every  such  corporation  and 
partnership  will  be  required  to  submit  a  balance  sheet  as  at  the  first  day 
of  the  taxable  year  and  also  a  balance  sheet  as  at  the  close  of  the  taxable 
year.  Thereafter  every  such  corporation  and  partnership  will  be  re- 
quired to  submit  a  balance  sheet  as  at  the  close  of  each  taxable  year. 
Balance  sheets  should  be  made  in  accordance  with  the  books  of  the  tax- 
payer and  changes  in  respect  of  any  items  therein  made  pursuant  to  these 
regulations  should  be  explained  in  a  separate  statement  attached  to  the 
balance  sheet  to  which  it  relates. 

54.  Stock  returned  to  corporation. — For  the  purpose  of  computing  in- 
vested capital,  in  cases  where  the  stock  of  a  corporation  is  issued  or  ex- 
changed for  property  (tangible  or  intangible),  the  following  rule  will 
apply: 

When  any  of  such  stock  is  returned  to  the  corporation  as  a  gift  or  for 
a  consideration  substantially  less  than  its  par  value,  the  stock  so  re- 
turned shall  not  be  treated  as  a  part  of  the  stock  issued  or  exchanged 


714  INCOME   AND    FEDERAL   TAX   REPORTS 

for  such  property.  The  proceeds  derived  in  cash  or  its  equivalent  from 
the  resale  of  the  stock  so  returned  shall,  however,  be  included  in  the  in- 
vested capital  if  retained  and  employed  in  the  business. 

55.  Valuation  of  tangible  property  paid  in  for  stock  or  shares. — Tan- 
gible property  paid  in  for  stock  or  shares  prior  to  January  1,  1914,  must 
be  valued  at  either  (a)  the  actual  cash  value  of  such  property  on  Jan- 
uary 1,  1914,  or  (b)  the  par  value  of  the  stock  or  shares  specifically 
issued  therefor,  whichever  is  lower.  This  is  one  of  the  few  eases  in 
which  the  law  permits  allowance  to  be  made  for  appreciation,  and  here 
no  appreciation  can  be  recognized  unless  the  original  stock  or  shares 
were  specifically  issued  in  exchange  for  such  tangible  property. 

Tangible  property  paid  in  for  stock  or  shares  on  or  after  January  1, 
1914,  will  be  taken  at  the  actual  cash  value  of  such  property  at  the  time 
of  payment,  irrespective  of  the  par  value  of  the  stock  or  shares. 

56.  Patents  and  copyrights. — Patents  and  copyrights  paid  in  for  stock 
or  shares  must  be  valued  at  either  (a)  the  actual  cash  value  at  the  time 
of  payment  or  (b)  the  par  value  of  the  stock  or  shares  issued  therefor, 
whichever  is  lower. 

57.  Valuation  of  intangible  property. — If  good  will,  trade  marks,  trade 
brands,  franchises  of  a  corporation  or  partnership,  or  other  intangible 
property  has  been  purchased  with  stock  or  shares  issued  prior  to  March 
3,  1917,  the  amount  that  may  be  included  in  invested  capital  must  not 
exceed  (a)  20  per  cent  of  the  par  value  of  the  total  stock  or  shares  out- 
standing on  that  date,  nor  (b)  the  actual  value  of  the  asset  at  the  date 
acquired,  nor  (c)  the  par  value  of  the  stock  issued  in  payment  for  the 
asset. 

58.  Application  of  20  per  cent  limitation  upon  intangible  property. — 
The  20  per  cent  limitation  upon  intangible  property  purchased  prior  to 
March  3,  1917,  for  or  with  stock  or  shares  of  the  corporation  or  partner- 
ship, applies  not  to  each  item  or  class  of  intangible  property  separately, 
but  to  the  aggregate  amount  of  all  such  property  so  purchased.  Such  in- 
tangible property  may  be  included  in  the  invested  capital  only  up  to  an 
amount  not  exceeding  20  per  cent  of  the  total  stock  or  shares  of  the  cor- 
poration or  partnership  on  March  3,  1917,  even  though  the  aggregate 
amount  of  such  intangible  property  be  greater  in  value  than  such  20  per 
cent  of  the  par  value  of  the  total  stock  or  shares. 

Intangible  property  bona  fide  purchased  prior  to  March  3,  1917,  with 
stock  having  no  par  value  may  be  included  in  invested  capital  at  a  value 
not  exceeding  the  actual  cash  value  of  such  intangible  property  at  the 
time  of  the  purchase  and  in  an  amount  not  exceeding  20  per  cent  of  the 
total  shares  of  stock  outstanding  on  March  3,  1917,  measured  by  their 
value  as  at  the  date  or  dates  of  issue. 

59.  Rules  to  govern  cases  where  shares  or  securities  are  issued  for 
mixed  aggregate  of  tangible  and  intangible  property. — Where  stock  or 
shares  (or  stocks  or  shares  and  bonds  or  other  obligations)  have,  prior  to 
March  3,  1917,  been  issued  for  a  mixed  aggregate  of — 

(a)  Tangible  property, 

(b)  Patents  and  copyrights,  and 

(c)  Good  will  or  other  intangible  property, 
the  following  rules  will  govern: 

(1)  In  the  absence  of  satisfactory  evidence  to  the  contrary,  it  will  be 
presumed,  in  the  case  of  a  corporation,  that  its  stock  was  issued  for  the 
following  purposes  in  the  order  named: 

(a)  Good  will  or  other  intangible  property, 

(b)  Patents  and  copyrights^  and 

(c)  Tangible  property. 

(2)  Upon  the  production  by  the  taxpayer  of  evidence  satisfactory  to 
the  Commissioner  of  Internal  Revenue  as  to  the  actual  values  at  the  date 
of  acquisition  of  (a)  the  tangible  property  and  (b)  the  patents  and  copy- 
rights, the  sum  of  these  two  items  may  be  applied  against  the  total  par 


WAR   EXCESS   PROFITS   TAX  715 

value  of  the  securities  issued  and  the  remainder  will  then  be  deemed  to 
represent  the  par  value  of  the  securities  issued  for  the  good  will  or  other 
intangible  property. 

(3)  Cases  where  mixed  aggregates  of  tangible  and  intangible  property 
have  been  paid  in  for  stock  and  bonds  shall,  if  the  Secretary  of  the 
Treasury  is  unable  to  determine  satisfactorily  the  respective  values  of 
the  several  classes  of  property  at  the  time  of  payment,  be  treated  as 
coming  under  articles  18  and  24  and  the  tax  shall  be  assessed  accordingly. 

60.  Valuation  of  intangible  assets  purchased. — Good  will  and  other 
similar  intangible  assets  purchased  with  cash  or  tangible  property  must 
be  taken  at  a  value  not  in  excess  of  the  cash  or  actual  cash  value  of  the 
tangible  property  specifically  paid  therefor. 

61.  Surplus  or  undivided  profits  earned  during  any  year  excluded  in 
computing  invested  capital  for  such  year. — Profits  earned  during  any 
taxable  year  or  pre-war  year  shall  not  be  included  in  the  computation  of 
the  invested  capital  for  such  year,  even  though  set  up  as  "surplus"  upon 
the  books  or  distributed  in  the  form  of  stock  dividends. 

62.  Scope  of  phrase  "surplus  and  undivided  profits." — Clause  (3)  of 
subdivision  (a)  of  section  207  authorizes  the  inclusion  in  invested  cap- 
ital of  earned  surplus  and  undivided  profits  used  or  employed  in  the 
business.  Inasmuch  as  section  201  provides  that  all  the  income  of  a  cor- 
poration or  partnership  shall  be  deemed  to  be  received  from  its  trade  or 
business,  all  the  surplus  and  undivided  profits  of  a  corporation  or  part- 
nership (exclusive  of  undivided  profits  earned  during  the  year),  from 
whatever  source  derived,  will,  unless  invested  in  stocks,  bonds  (other 
than  obligations  of  the  United  States),  or  other  assets,  the  income  from 
which  is  not  subject  to  the  excess  profits  tax,  be  deemed  to  be  used  or 
employed  in  the  business  and  may  be  included  in  the  invested  capital. 

63.  When  tangible  property  may  be  included  in  surplus. — Where  it  can 
be  shown  by  evidence  satisfactory  to  the  Commissioner  of  Internal 
Eevenue  that  tangible  property  has  been  conveyed  to  a  corporation  or 
partnership  by  gift  or  at  a  value,  accurately  ascertainable  or  definitely 
known  as  at  the  date  of  conveyance,  clearly  and  substantially  in  excess 
of  the  cash  or  the  par  value  of  the  stock  or  shares  paid  therefor,  then 
the  amount  of  the  excess  shall  be  deemed  to  be  paid  in  surplus.  The 
adopted  value  shall  not  cover  mineral  deposits  or  other  properties  dis- 
covered or  developed  after  the  date  of  conveyance,  but  shall  be  confined 
to  the  value  accurately  ascertainable  or  definitely  known  at  that  time. 

Evidence  tending  to  support  a  claim  for  a  paid-in  surplus  under  these 
circumstances  must  be  as  of  the  date  of  conveyance,  and  may  consist, 
among  other  things,  of  (1)  an  appraisal  of  the  property  by  disinterested 
authorities,  (2)  the  assessed  value  in  the  case  of  real  estate,  and  (3)  the 
market  price  in  excess  of  the  par  value  of  the  stock  or  shares. 

64.  Reconstruction  of  surplus  and  undivided  profits  accounts. — Where 
through  failure  to  provide  for  depletion,  depreciation,  obsolescence,  or 
other  expenses  or  losses,  or  where  for  any  other  cause  or  reason  the  books 
of  account  of  the  taxpayer  do  not  show  the  true  paid-in  or  earned  sur- 
plus and  undivided  profits,  in  the  computation  of  invested  capital  such 
adjustments  shall  be  made  as  are  necessary  to  arrive  at  a  statement  of 
the  correct  amount. 

Where  a  taxpayer  claims  additions  to  the  capital  account,  the  books  of 
account  will  be  presumed  to  show  the  true  facts  and  the  burden  of  proof 
will  rest  upon  the  taxpayer.  Such  additions  will  be  accepted  only  to 
the  extent  and  under  the  conditions  stated  below: 

(1)  Amounts  which  have  been  expended  in  the  past  for  the  acquisi- 
tion of  plant,  equipment,  tools,  patterns,  furniture,  fixtures,  or  like  tan- 
gible property,  having  a  useful  life  extending  substantially  beyond  the 
year  in  which  the  expenditure  was  made,  and  which  have  been  charged 
as  current  expenses,  may  (less  proper  reduction  for  depreciation  or  obso- 
lescence) be  added  to  the  surplus  account  in  computing  invested  capital 


716         INCOME    AND    FEDERAL    TAX    REPORTS 

when  such  assets  are  still  owned  and  in  active  use  by  the  taxpayer  dur- 
ing the  taxable  year.  Special  tools,  patterns,  and  similar  assets  shall 
not  be  assigned  any  value  if  their  cost  has  been  recovered  through  hav- 
ing been  included  in  the  price  of  goods.  If  their  cost  has  not  been  so 
recovered  and  they  are  held  for  only  occasional  use,  they  shall  not  be 
assigned  a  value  in  excess  of  the  fair  value  based  upon  the  earnings 
actually  arising  from  their  current  use.  Assets  of  this  kind  not  in  cur- 
rent use  shall  not  be  valued  at  more  than  their  nominal  or  scrap  value. 

(2)  Amounts  expended  in  the  past  for  good  will,  trade-marks,  trade 
brands,  franchises,  and  other  intangible  assets  of  a  like  character,  are 
controlled  by  the  language  of  the  statute,  which  provides  that  such  assets 
"shall  be  included  in  invested  capital  if  the  corporation  or  partnership 
made  payment  bona  fide  therefor  specifically  as  such  in  cash,  or  tangible 
property."  The  Commissioner  of  Internal  Revenue  will  recognize  addi- 
tions to  invested  capital  on  account  of  intangible  assets  only  if  such 
assets  have  been  explicitly  paid  for  in  the  manner  prescribed  by  the 
statute.  Where  expenditures  have  been  made  for  the  general  develop- 
ment of  intangible  assets,  and  charged  as  current  expense,  no  readjust- 
ment thereof  will  be  allowed. 

(3)  Amount's  under  (1)  and  (2)  above,  expended  on  or  after  March 
1,  1913,  will,  in  the  case  of  a  corporation,  be  limited  strictly  to  items 
which  have  not  been  deducted  in  computing  taxable  income  upon  its  in- 
come tax  return.  Whenever  a  corporation  has  claimed  and  the  depart- 
ment has  allowed  a  deduction  in  respect  to  its  income  tax,  the  item  upon 
which  the  deduction  is  based  shall  not  be  restored  to  the  surplus  account 
nor  included  in  the  invested  capital. 

(4)  The  taxpayer  shall  in  his  return  to  the  Commissioner  of  Internal 
Revenue  make  a  statement  of  the  proposed  additions,  specifying  the 
kinds  and  amounts  of  property  involved,  the  years  in  which  the  expen- 
ditures were  made,  and  the  method  followed  in  distinguishing  between 
capital  outlays  and  current  expenses. 

(5)  The  taxpayer  shall  also  show  that  adequate  provision  has  been 
made  for  the  depletion,  depreciation,  or  obsolescence  of  such  of  the 
assets  so  acquired  as  are,  under  the  rulings  of  the  department,  subject  to 
recognized  depreciation. 

65.  Invested  capital  of  insurance  companies. — (a)  The  invested  cap- 
ital of  a  mutual  insurance  company  will  be  deemed  to  consist  of  the 
sum  of  (1)  any  surplus  or  contingent  reserves  maintained  for  the  gen- 
eral use  of  the  business,  plus  (2)  any  legal  reserves  the  net  additions  to 
which  are  included  in  the  net  income  subject  to  the  tax — subject  to  the 
restrictive  provisions  of  article  44  requiring  the  exclusion  of  tax-fiee 
assets  other  than  obligations  of  the  United  States. 

(b)  The  invested  capital  of  a  stock  insurance  company  will  be  deemed 
to  consist  of  its  capital  stock,  paid  in  or  earned  surplus  and  undivided 
profits  (subject  to  the  same  restrictive  provision  or  art.  44),  computed 
in  accordance  with  the  provisions  of  article  53. 


INVESTED  CAPITAL— INDIVIDUALS 

66.  Items  included  in  invested  capital. — Subject  to  the  limitations 
stated  in  these  regulations  the  invested  capital  of  an  individual  is  meas- 
ured by  the  total  of  three  items: 

(1)  Actual  cash  paid  into  the  trade  or  business. 

(2)  Tangible  property  paid  into  the  trade  or  business. 

(3)  Patents  and  copyrights,  and  good  will,  trade-marks,  trade  brands, 
franchises,  and  other  intangible  property.     (See  art.  68.) 

67.  Valuation  of  tangible  property. — Subject  to  the  requirements  of 
article  42  as  to  allowance  for  depletion,  depreciation  and  obsolescence, 
valuation  of  tangible  property  will  be  as  follows: 


WAR   EXCESS   PROFITS    TAX  717 

In  the  case  of  tangible  property  purchased  with  cash,  the  valuation 
will  be  based  upon  the  cost  (estimated  if  not  known)  in  cash  at  the 
time  purchased. 

In  the  case  of  tangible  property  paid  in  as  such  prior  to  January  1, 
1914,  the  valuation  will  be  based  upon  its  actual  cash  value  as  of  that 
date.  Adequate  evidence  of  such  value  must  be  furnished  by  the  tax- 
payer. 

In  the  case  of  tangible  property  paid  in  on  or  after  January  1,  1914, 
the  valuation  will  be  based  upon  its  actual  cash  value  at  the  time  of 
payment. 

It  will  be  presumed  that  the  tangible  assets  employed  in  the  trade  or 
business  have  been  acquired  with  cash  which  has  been  either  paid  in 
directly  or  derived  from  earnings  of  the  trade  or  business;  but  the  tax- 
payer will  be  entitled  to  show  that  such  assets  were  paid  in  as  tangible 
property. 

68.  Valuation  of  intangible  property. — Patents  and  copyrights,  and 
good  will,  trade-marks,  trade  brands,  franchises,  and  other  similar  in- 
tangible assets  may  be  included  in  invested  capital  at  a  value  not  to 
exceed  the  actual  cash  paid  therefor  or  the  actual  cash  value  at  the 
time  of  payment  of  the  tangible  property  paid  therefor,  but  only  if 
bona  fide  payment  was  made  therefor  specifically  as  such  in  cash  or 
tangible  property. 

69.  Profits  earned  during  taxable  year  may  be  included. — The  restric- 
tion in  respect  of  undivided  profits  earned  during  the  taxable  year  which 
is  imposed  upon  corporations  and  partnerships  does  not  apply  to  indi- 
viduals, and  therefore,  unless  otherwise  shown,  the  profits  of  the  taxable 
year  remaining  in  the  trade  or  business  will  be  deemed  to  have  arisen 
ratably  throughout  the  year,  and  the  capital  at  the  beginning  of  the 
year  may  be  increased  by  the  total  amount  of  such  profits  remaining  in 
the  trade  or  business  averaged  monthly  over  the  year. 

70.  Rule  for  computing  invested  capital. — Where  an  individual  keeps 
books  of  account  his  invested  capital  will  be  found  in  his  capital  ac- 
count (under  whatever  name  it  may  be  called)  after  making  therein  any 
adjustments  or  corrections  required  by  these  regulations,  provided  that 
the  assets  other  than  those  not  allowed  to  be  included  equal  or  exceed 
the  amount  of  such  capital  account.  Otherwise  the  invested  capital  shall 
be  the  amount  of  such  assets. 

Where  an  individual  does  not  keep  books  of  account  he  should  pre- 
pare and  preserve  a  statement  as  at  the  beginning  of  the  taxable  year 
and  as  at  the  end  of  the  taxable  year,  showing  in  full  all  his  assets  val- 
ued in  accordance  with  these  regulations,  and  all  his  liabilities.  The 
excess  of  such  assets  over  such  liabilities  at  the  beginning  of  the  year 
and  again  at  the  end  of  the  year  will  constitute  the  invested  capital 
of  the  individual  on  those  dates,  respectively,  provided,  that  in  each  case 
the  assets  other  than  those  not  allowed  to  be  included  equal  or  exceed 
the  amount  of  such  excess.  Otherwise  the  invested  capital  shall  be  the 
amount  of  such  assets.  The  amount  of  the  difference  between  the  cap- 
ital thus  shown  as  at  the  beginning  of  the  year  and  at  the  end  of  the 
year  will,  in  the  absence  of  evidence  to  the  contrary,  be  deemed  to  have 
arisen  ratably  throughout  the  year,  and  the  capital  at  the  beginning  of 
the  year  will  be  increased  or  decreased,  as  the  case  may  be,  by  such 
amount  averaged  monthly  over  the  year. 

If  an  individual  is  engaged  in  more  than  one  trade  or  business  having 
invested  capital,  then  his  invested  capital  for  the  purposes  of  comput- 
ing the  deduction  and  applying  the  rates  of  taxation  will  be  determined 
by  taking  the  total  invested  capital  of  all  such  trades  or  businesses. 

The  terms  "assets"  and  "liabilities"  as  used  in  this  article  relate 
only  to  the  assets  or  liabilities  of  the  trade  or  business. 


718  INCOME   AND   FEDERAL    TAX   REPORTS 

NOMINAL   CAPITAL 

71.  Application  of  section  209. — Section  209  (see  art.  15)  applies  pri- 
marily to  occupations,  professions,  trades  and  businesses  engaged  prin- 
cipally in  rendering  personal  service  in  which  the  employment  of  capital 
is  not  necessary  and  the  earnings  of  which  are  to  be  ascribed  primarily 
to  the  activities  of  the  owners. 

In  determining  whether  a  trade  or  business  is  taxable  under  article 
15  no  weight  will  be  given  to  the  fact  that  it  is  carried  on  by  means  of 
personal  service  unless  the  principal  owners  are  regularly  engaged  in  the 
active  conduct  of  the  trade  or  business. 

72.  Application  of  section  209  not  to  be  affected  by  mere  size  of  cap- 
ital, form  of  organization,  etc. — Business  concerns  which  render  profes- 
sional or  personal  service  and  are  of  the  class  normally  taxable  under 
article  15  shall  not  be  taken  out  of  that  class  merely  because  of  the 
size  of  the  capital  if  the  employment  of  such  capital  is  necessitated  by 
delay  and  irregularity  in  the  receipt  of  fees,  etc.,  or  if  such  capital  is 
wholly  or  mainly  used  as  a  fund  from  which  to  advance  salaries,  wages, 
etc.,  or  to  provide  office  furniture,  accommodations,  and  equipment,  nor 
because  of  the  form  of  organization,  whether  corporation  or  partnership, 
nor  in  the  case  of  a  partnership  because  of  the  number  of  partners. 

73.  Agents  and  brokers. — Agents  and  brokers  requiring  and  using  no 
capital  or  merely  a  nominal  capital  in  their  business  are  taxable  under 
article  15,  but  commission  houses  regularly  employing  a  substantial 
amount  of  capital,  whether  to  lend  to  principals  or  to  carry  goods  on 
their  own  account,  are  not  deemed  to  be  agents  or  brokers  and  are  tax- 
able under  the  provisions  of  article  16. 

74.  Meaning  of  ''nominal  capital";  businesses  which  will  not  be 
deemed  to  have  nominal  capital. — The  term  "nominal  capital"  as  used 
in  section  209  means  in  general  a  small  or  negligible  capital  whose  use 
in  a  particular  trade  or  business  is  incidental.  The  following  will  not  be 
construed  as  businesses  having  a  nominal  capital  for  purposes  of  excess 
profits*  tax : 

(a)  A  business  which  because  of  conditions  arising  from  the  war  or 
exceptional  opportunities  for  profits  earns  a  disproportionately  high  rate 
of  profit  during  the  taxable  year,  if  it  belongs  to  a  class  which  neces- 
sarily and  customarily  requires  capital  for  its  operation.  In  the  de- 
termination of  doubtful  cases  stress  will  be  laid  upon  the  normal  rela- 
tion of  net  income  to  capital  during  pre-war  years; 

(b)  Corporations  which,  although  their  capitalization  is  nominal,  em- 
ploy a  substantial  amount  of  capital  in  their  business; 

(c)  A  business  having  a  substantial  capital,  but  whose  invested  cap- 
ital within  the  meaning  of  section  207  is  reduced  to  a  nominal  amount 
by  the  operation  of  the  restrictive  clauses  of  that  section,  e.  g.,  where 
the  capital,  consisting  originally  of  a  small  amount  of  cash  paid  in,  has 
since  appreciated  in  value,  or  where  the  capital  is  largely  covered  by 
indebtedness  or  consists  principally  of  tax-free  securities  or  of  intan- 
gible assets  built  up  or  developed  by  expenditures  which  have  been  regu- 
larly deducted  as  items  of  current  expense. 

RETURNS 

75.  When  a  return  of  information  as  to  the  invested  capital  and  net 
income  for  the  pre-war  period  will  not  be  required. — For  the  purposes  of 
the  excess  profits  tax,  a  return  of  information  with  respect  to  the  invested 
capital  and  net  income  for  the  pre-war  period  will  not  be  required  of  a 
corporation,  partnership  or  individual  in  the  following  cases: 

(1)  If  the  taxpayer  accepts  the  minimum  percentage,  viz.,  7  per  cent, 
as  the  percentage  to  be  used  in  computing  the  deduction  under  article 
21;  or 


WAR   EXCESS   PROFITS    TAX  7 19 

(2)  If  the  trade  or  business  is  taxable  only  at  the  8  per  cent  rate  un- 
der article  15. 

This  article  must  not  be  construed  as  not  requiring  a  return  of  infor- 
mation as  to  all  facts  which  may  be  necessary  for  the  ascertainment  of 
the  capital  and  income  for  the  taxable  year  whenever  such  a  return  is 
required  by  the  Commissioner  of  Internal  Eevenue. 

76.  A  married  woman  may  make  separate  return. — A  married  woman 
who  is  a  sole  trader  or  is  entitled  to  any  taxable  income  to  her  sole  and 
separate  use  may,  for  purposes  of  the  excess  profits  tax,  make  a  separate 
return  in  the  same  manner  as  any  other  individual. 

77.  When  affiliated  corporations  must  furnish  information  as  to  inter- 
corporate relations. — For  the  purpose  of  the  excess  profits  tax  every 
corporation  will  describe  in  its  return  all  its  intercorporate  relationships 
with  other  corporations  with  which  it  is  affiliated,  and  will  furnish  such 
information  in  relation  thereto  as  will  enable  the  Commissioner  of  In- 
ternal Revenue  to  compute  the  amount  of  the  tax  properly  due  from  each 
corporation  on  the  basis  of  an  equitable  and  lawful  accounting. 

For  the  purpose  of  this  regulation  two  or  more  corporations  will  be 
deemed  to  be  affiliated  (1)  when  one  such  corporation  owns  directly  or 
controls  through  closely  affiliated  interests  or  by  a  nominee  or  nominees, 
all  or  substantially  all  of  the  stock  of  the  other  or  others,  or  when  sub- 
stantially all  of  the  stock  of  two  or  more  corporations  is  owned  by  the 
same  individual  or  partnership,  and  both  or  all  of  such  corporations  are 
engaged  in  the  same  or  a  closely  related  business;  or  (2)  when  one  such 
corporation  (a)  buys  from  or  sells  to  another  products  or  services  at 
prices  above  or  below  the  current  market,  thus  effecting  an  artificial 
distribution  of  profits,  or  (b)  in  any  way  so  arranges  its  financial  rela- 
tionships with  another  corporation  as  to  assign  to  it  a  disproportionate 
share  of  net  income  or  invested  capital. 

78.  When  affiliated  corporations  may  be  required  to  make  consolidated 
return. — Whenever  necessary  to  more  equitably  determine  the  invested 
capital  or  taxable  income,  the  Commissioner  of  Internal  Eevenue  may 
require  corporations  classed  as  affiliated  under  article  77  to  furnish  a 
consolidated  return  of  net  income  and  invested  capital. 

Where  such  consolidated  return  is  required  it  may  be  made  by  any  one 
or  more  of  such  corporations  or  by  all  of  them  acting  jointly;  but  if  such 
affiliated  corporations,  when  requested  to  file  such  consolidated  returns, 
neglect  or  refuse  to  do  so,  the  Commissioner  of  Internal  Revenue  may 
cause  an  examination  of  the  books  of  all  such  corporations  to  be  made  and 
a  consolidated  statement  to  be  made  from  such  examination.  In  cases 
where  consolidated  returns  are  accepted,  the  total  tax  will  be  computed 
in  the  first  instance  as  a  unit  upon  the  basis  of  the  consolidated  return 
and  will  be  assessed  upon  the  respective  affiliated  corporations  in  such 
proportions  as  may  be  agreed  among  them.  If  no  such  agreement  is 
made  the  tax  will  "be  assessed  upon  each  such  corporation  in  accordance 
with  the  net  income  and  invested  capital  properly  assignable  to  it. 

ASSESSMENT    AND    COLLECTION 

79.  Assessment  and  collection  governed  by  income  tax  regulations. — 
All  excess  profits  taxes  to  which  any  taxpayer  is  subject  shall  be  assessed 
and  collected  at  the  same  times  and  in  the  same  manner  as  provided  with 
respect  to  income  taxes  in  the  income  tax  regulations  in  so  far  as  the 
same  are  applicable. 


INDEX 


(Figures  in  italics  refer  to  law) 


Abatement,  claims  for,  27,  698 
Accident  insurance,  77;  losses,  116 
Accounting,  corporation,  180,  189 
Accrual  basis,  102,  207;  salaries,  209 
Accrued  interest  on  bonds,  193 
Additional  tax,  131,  341 
Additions  to  property,  216-221 
Ad  interim  certificates,  tax  on,  526 
Adjustment  of  surplus  account,  un- 
der Excess  Profits  tax,  672;  exam- 
ple, 683 
Administration   of   tax  laws,    17-31, 

329,  345 
Administrator,    defined,    282;    ancil- 
lary, 287 
Admissions,  defined,  608;  free,  598, 

606]   exemptions,  607 
Admissions   and   dues,   tax   on,   596, 

606 
Admissions,  returns,  604;   penalties, 

605 
Advance  payment  of  tax,  161 
Advisory     Boards,     "Legal"     and 

"Excess  Profits,"  17 
Affiliated  corporations,  696,  719 
Agents  and  brokers   using   nominal 

capital,  718 
Agricultural  corporations,  170-177 
Airdomes,  tax  on  proprietors  of,  463 
Alimony,  78,  104 

American    Eadiator    Co.,    dividends 
paid  from  surplus  earned  prior  to 
March  1,  1913,  83 
Amortization,     68,     193;     munitions 

tax,  447 
Ancillary  administrator,  287 
Annuities,  40 

"Appendages,"  Munitions  tax,  438 
Appreciation  of  assets,  202;  adjust- 
ments for  under  Excess  Profits 
tax,  676 
Assessments  on  stockholders,  107, 198 
Assessment  and  administration,  309, 

326;  Excess  Profits  tax,  719 
Assets,  revaluation  of,  80;   sale  of, 
199,  202;  cost  of,  223;  life  of,  224 


Associations,  165;  charitable,  175 

Athletic  associations,  603,  608 

Audit  of  returns,  26 

Automobile  accidents,  cost  of,  when 
deductible,  117 

Automobiles,  upkeep,  when  deduct- 
ible, 104 


Bad  debts,  78,  120;  classes  of,  de- 
ductible, 120;  individual,  partner- 
ship and  corporation  bad  debt 
losses,  121,  198,  220 

Bank  deposits,  interest  on,  67 

Banks,  private,  79,  171;  co-opera- 
tive, 174 

Baumbach  vs.  Sargent  decision,  354 

Beer,  ale  and  porter,  war  tax  on, 
516 

Beneficiaries,  duties  of  under  estate 
tax,  397 

Beneficiary,  defined,  283;  foreign, 
287;  tax  paid  by,  294 

Bethlehem  Steel  Corporation,  divi- 
dend paid  by,  86 

Beverages,  tax  on,  493 

Billiard  rooms,  tax  on,  467 

Boats,  tax  on,  487,  4-91 

Bond  yields,  effect  of  tax  on,  136- 
137  (Charts) 

Bonded  indebtedness,  reduction  of, 
198 

Bonds  purchased  above  or  below  par, 
68,  69,  193,  200;  Stamp  Tax  on, 
522 

Bonuses,  51,  210 

Book  appreciation,  57,  200;  depre- 
ciation, 218 

Bowling  alleys,  tax  on,  467,  473 

Brackets,  in  Excess  Profits  grad- 
uated tax  computation,  693 

Branch  corporations,  171,  172 

Brokers,  losses,  when  deductible, 
120;  tax  on,  459,  471;  under  Ex- 
cess Profits  tax,  649 

Building  and  loan  shares,  98,  174 


721 


722 


INDEX 


Buildings,  losses  in  reconstruction 
of,  118;  on  leased  ground,  216 

Business,  income  from,  52;  losses, 
113;  defined,  114;  transaction  of, 
defined,  353;  individual  engaged 
in  more  than  one,  688 


Cabarets,  602,  607;  time  of  filing 
returns,  604 

Cameras,  tax  on,  486,  490 

Campaign  contributions,  211 

Capital,  constructive,  703 

Capital  account,  adjustment  of,  for 
intangible  property,  668;  tangible 
property,  669,  670;  mixed  tan- 
gible and  intangible  property, 
670;  example,  682 

Capital  assets,  sale  of,  202 

Capital  stock  certificates,  tax  on, 
525 

Capital  stock,  valuation  of,  362; 
earnings  required  to  maintain  par 
value,  365 

Capital  stock,  tax  on  original  issue, 
569;  sales  or  transfers,  526,  569; 
regulations,  528-543 

Capital  Stock  tax,  347;  corporations 
liable,  348;  basis  of,  361;  rate 
and  computation,  375,  381-384;  on 
foreign  corporations,  376 

Casualty  insurance,  tax  on,  587,  594 

Cash  discounts,  186 

Cemetery  companies,  175 

Certificates  of  indebtedness,  524 

Champagne,  tax  on,  517 

Charts  of  tax  rates,  127,  133-137; 
interest,  164;  depreciation,  225 

Checks,  in  tax  payment,  346 

Cigarettes  and  cigars,  see  Tobacco 

Circuses,  tax  on  proprietors  of,  464, 
472 

Citizen,  defined,  36 

Civic  leagues,  175 

Civil  War  and  other  taxes,  1-12 

Clearing  house,  defined,  529,  545; 
records  kept  by,  550,  552;  returns 
made  by,  554 

Clergymen,  income  of,  defined,  50 

Close  corporations,  168 

Clothing,  expense  not  deductible, 
104 

Club  dues,  tax  on,  603 

Clubs,  social,  175 

Collection  districts  and  collectors, 
609;  New  York  City,  623 

Collector,  returns  made  by,  331 

Commissions,  real  estate,  106 

Commutation,  expense  not  deduc- 
tible, 48,  106 


Composition  in  bankruptcy,  121 

Compromise,  of  tax  suits,  28;  of  in- 
debtedness, 121,  198 

Conservator,  defined,  282 

Consolidated  concerns,  697;  returns 
of,  697 

Consolidated  returns,  719 

Constructive  capital  for  application 
of  rates,  703 

Contracts,  uncompleted,  57,  189; 
paid  for  in  stock,  208 

Contributions,  100,  113,  302,  709 

Corporations  owned  by  exempt  or- 
ganizations, 168;  in  existence  for 
part  of  year,  168;  dissolved,  168; 
in  liquidation,  169;  not  transact- 
ing business,  169;  not  entirely  or- 
ganized, 170;  exempt,  172 

Cost  or  market  valuation,  54,  183, 
184 

Credit  insurance,  premiums  deduc- 
tible, 221 

Custom  house  brokers,  tax  on,  462 

Custom  house  entries  and  withdraw- 
als, tax  on,  558,  573 

Customs  duties  deductible,  112 


Damages  recovered,  77 

Dance  halls,  tax  on  admission  to, 
602 

Dealer  in  securities,  115,  185 

Debentures,  524 

Debts,  deductible,  302,  304 

Decedent's  estate,  128;  non-resident, 
285,  287,  393 

Declining  balance  methods  of  calcu- 
lating depreciation,   227 

Deduction  at  the  source,  258 

Deductions,  under  Income  Tax,  indi- 
viduals, 99;  corporations,  206; 
under  Excess  Profits  tax,  691 

Deferred  dividends,  191 

Depletion,  defined,  233;  of  mines, 
233;  basis  for  value  as  of  March 
1,  1913,  233;  cost  basis,  234;  cal- 
culation of  depletion,  235;  book- 
keeping requirements,  235;  lessees, 
236;  oil  and  gas  wells,  237;  of  oil 
field,  239;  of  timber  land,  241;  of 
agricultural  land,  242 

Depositors'  guaranty  fund,  214 

Depreciation,  100;  on  buildings, 
119;  on  idle  plant,  122;  limited  to 
cost,  123;  accounting  methods, 
123;  rate  of,  223;  chart,  225;  of 
intangible  assets,  230;  under  Mu- 
nitions tax,  447;  Excess  Profits 
tax,  677 


INDEX 


723 


Depreciation  reserve,  conversion 
into  tangible  assets,  233;  of  in- 
surance companies,  243 

Dictaphones,  482 

Discount  on  bonds,  in  accounting, 
69;  tables,  413-416 

Discounts,  186 

Dissolved  corporations,  168;  inac- 
tive, 169 

Distributable  profits,  of  partner- 
ship, 114 

Dividends,  78-87,  128-130;  of  other 
corporations,  167;  income  from, 
195,  297;  paid  out  of  most  re- 
cently accumulated  surplus,  197; 
salaries  representing,  210;  with- 
holding provisions,  270 

Division  of  business  co-operation, 
19 

Divisions,  Internal  Eevenue,  and 
agents  in  charge,  619 

Divorced  persons,  78 

Domiciliary  administrator,  287 

Donations,  212 

Drafts,  stamp  tax  on,  557,  572 

Dues,  105;  tax  on,  596 

Duties,  customs,  deductible,  112 


Electric  motor  boats,  taxable,  439 
Employees'  accident  insurance,  77 
Employees,  retired,  210 
Endorsement    of   note   of   insolvent, 

122 
English  Excess  Profits  tax,  8-13 
Estate  during  period  of  settlement, 
286;  income  of  reported  by  fidu- 
ciary, 289,  298 
Estates,  exemption  allowed,  132 
Estate  tax,  385,  422,  430,  482;  ear- 
lier measures,  385-387;  definitions, 
387;  gross  estate,  388;  net  estate, 
residents ',  391 ;  non-residents ',  931 ; 
specific  exemption,  391;  "30-day 
notice,"  394;  duties  of  executors 
and  administrators,  394,  426;  of 
beneficiaries,  397;  of  banks  and 
safe  deposit  companies,  401;  of 
agents  of  non-resident  decedents, 
404;  of  corporate  agents,  406;  re- 
turns, 408;  tentative  and  final  re- 
turns, 409;  gifts  in  contemplation 
of  death,  410,  424;  valuation  of 
stocks  and  bonds,  411;  discount 
for  prepayment,  414;  discount  ta- 
bles, 416;  rates  of  tax,  418,  423, 
431,  432;  payment,  419,  425,  427; 
penalties,  421,  429 
Ethyl  and  denatured  alcohol,  512 


Excess  Profits  Advisory  Board,  17, 
18 

Excess  Profits  tax,  8;  English,  9; 
law,  625-638;  chapter  on,  639-698; 
regulations,  699-719;  who  must 
pay,  640,  700;  8  per  cent  tax, 
644;  income  exempt,  627,  645; 
specific  exemptions,  645;  returns, 
650;  graduated  tax,  650;  income 
taxable,  651;  amount  how  deter- 
mined, 652;  rates,  626;  deductions, 
628;  law  of  March  3,  1917,  re- 
pealed, 637;  credit  for  taxes  paid 
under,  637;  example  of  computa- 
tion of  invested  capital,  681; 
consolidated  returns  under,  697; 
deduction  for  income  tax,  697; 
claims  for  abatement,  697;  rate 
and  computation,  700 

Exchange  of  securities,  61 

Excise  tax  on  corporations,  375 

Excise  taxes  on  commodities,  477, 
490 

Executor  defined,  282 

Exempt  corporations,  315 

Exempt  income,  39-46;  earned  prior 
to  1913,  44,  300,  305;  of  foreign 
governments,  338 

Exemptions,  personal,  127,  305 

Expenses,  when  deductible,  48;  al- 
lowance for  traveling,  50;  busi- 
ness and  partnership,  102;  per- 
sonal, 103;  landlord's,  106;  ordi- 
nary and  necessary,  206;  capital 
expenses  and  income  expenses  dif- 
ferentiated, 206;  cash,  accrued  or 
prepaid  expenses,  207;  other  than 
cash,  208;  distinguished  from  gra- 
tuities, 212;  organization,  214 

Explosives,  tax  on  manufacturers  of, 
438 

Express  charges,  tax  on,  581,  590 

Express  companies,  tax  on,  460 

Extensions,  307 


Fair  market  price,  64,  203 

Fairs,  tax  on,  603 

False  or  fraudulent  returns,  see  Pen- 
alties 

Farm,  income  from,  52,  65;  deduc- 
tions, 107;  expenses,  102 

Farm  loan  associations  exempt,  177 

Farm  products,  held  for  higher 
prices,  108 

Farmer,  defined,  65;  deductions  al- 
lowed, 107 

Farmers'   associations,   177 

Federal  estate  tax,  385 

Federal  farm  loans,  income  from,  39 


724 


INDEX 


Federal  Keserve  banks,  dividends  of, 

198 
Fees,    professional    and    vocational, 

52 
Fidelity  bond  premiums,  105 
Fiduciaries,    70,    151;    defined,    281; 

returns  of  information  by,  278 
Fiduciaries,    returns    filed    by,    283, 

289,  307;  taxes  paid  by,  284-294; 

gross  income  reported  by,  289 
Filing  returns,  see  Eeturns 
Firearms,  438 
Fire  losses,  116 
Fiscal  year,   partnership,    132,   151; 

of  corporation,  253,  698;  rates  ap- 
plicable to,  253;  returns  on  basis 

of,  255 
"Fixed    percentage,"    depreciation, 

226 
Floor    taxes    on    commodities,    478, 

490,  512,  517 
Foreign    concerns,    income    from    U. 

S.,  75;  from  foreign  sources,  75 
Foreign  corporations,  171,  259,  320, 

628;  subject  to  capital  stock  tax, 

348,  360,  382 
Foreign  income,  75 
Foreign  tax  payments,  35 
Fraternal  societies,  174 
Fraudulent  returns,  see  Penalties 
Freight  charges,  tax  on,  577,  590 
Fruit  growers'  associations,  173,  177 
Future  sales,  tax  on,  544 

Gain  or  loss,  computation  of  by  in- 
ventory method,  181 

Gas  wells,  depletion  of,  237 

Gifts  and  legacies,  property  ac- 
quired through,  41,  144 

Gifts  or  bonuses,  when  classed  as 
income,  50,  210 

Good-will,  60,  202,  231;  donations 
for  obtaining,  212;  under  Excess 
Profits  tax,  675;  not  subject  to 
appreciation  or  depreciation,  676 

Government  officials,  expenses  of, 
43,  49;  reimbursement  of,  49 

Greenhouse  losses,  by  frost,  etc., 
116 

Graduated  tax,  determination  of 
amount  of,  690;  where  concern 
not  in  business  during  pre-war 
period,  691 

Gross  estate,  defined,  388,  U23;  net 
estate,  391 

Gross  income  of  individuals,  44;  of 
corporations,  180;  of  insurance 
companies,  189 

Gross  profit,  computing,  53 


Gross  receipts   and   deductions,   142 
Guardian,  defined,  127,  128,  281 
Gulf  Oil   Corporation  vs.  Lewellyn, 
83 


Head  of  family,  1916  law,  130;  1917 

law,  132,  306 
Heirs   and   other  beneficiaries,  397; 

30-day  notice  filed  by,  399 
Holding  companies,   195,  350 
Husband  and  wife,  127 
Hypothecation  of  stock,  97 


Improvements  to  property,  123,  302 
Inactive  corporations,  169;  not  sub- 
ject to  Capital  Stock  tax,  349,  382 
Income,    defined,    37;    when    report- 
able,   39,    44,    46,    78;    total   net, 
151;    deductions   allowed,  38;    ex- 
empt, 39,  300;  earned  in  previous 
years,  44,  45;   book  value   appre- 
ciation of,  57;  from  business,  52; 
from  sales  of  property,  59;  from 
farm,  65;  from  interest,  67;  from 
tenants'  improvements,   67;   from 
fiduciaries,  70;  from  partnerships, 
71-74;    from   special    sources,    76; 
from  bad  debts,  79;  from  private 
banks,  79;  from  rentals,  191;  from 
dividends,  297;  not  tax -paid,  145; 
taxable  and  non-taxable,   199;   of 
individuals,   defined,  298;   subnor- 
mal, how  determined,  692 
Income  Tax,  296;  of  1894,  2;  1909, 
1913,  3;  1916,  4;  present  law,  32; 
when  deductible,  111;  rate  of  tax, 
252 
Indebtedness  outstanding,  249 
Indemnity  bonds,  tax  on,  525 
Individual  gross  income,  deductions 

from,  99 
Individual  income  tax,  32;  rate  of 

tax,  126;  computation,  155 
Individuals  liable  to  tax,  126 
Information  at  source,  258,  277  336 
Inheritance  of  property,  41 
Inheritance    taxes,    not    deductible, 
111;  Federal  Inheritance  tax,  385 
Insane  persons,  income  of,  285-288 
Insanitary  buildings,  destruction  of, 

119 
Insurance,  40,  41;  commissions  of 
agents,  51;  accident,  77;  pre- 
miums, 106;  paid  in  advance,  207; 
tax  on,  587,  593 
Insurance  companies,  depreciation, 
189-191;  reserves  of,  243 


INDEX 


725 


Intangible  property,  when  invested 
capital,  633,  663;  average,  663; 
adjustment  of  capital  account, 
668;  valuation  of,  686;  defined, 
711;  "20  per  cent  limitation," 
714;  valuation  of,  715,  717 

Intercorporate  relations,  informa- 
tion of  required,  719 

Interest  received,  67-75,  192-194, 
246;  paid,  109,  243,  246,  301,  320; 
on  loans  for  purchase  of  Liberty 
bonds,  109,  153;  on  U.  S.  bonds, 
130,  144;  on  sinking  fund,  194; 
paid  for  use  of  property,  245; 
calculation  of  amount  deductible, 
247,  249 

Internal  Revenue,  organization,  18 

Interpretation  of  tax  laws,  19 

Inventory  valuation,  at  cost  or  mar- 
ket, 54;  practical  considerations, 
54;  at  end  of  fiscal  year,  55,  142, 
185 

Invested  capital,  defined,  632;  of 
corporation  or  partnership,  633, 
666;  of  individual,  634,  685,  716; 
of  foreign  corporation  or  partner- 
ship, 634;  of  non-resident  alien, 
634;  indeterminable,  635,  689, 
705;  when  ownership  has  changed, 
665;  computation  of,  663,  666, 
681,  688,  717;  adjustments,  679, 
681,  684,  712;  general  provisions, 
710;  for  pre-war  period,  712;  in 
exceptional  cases,  712 

Irrigation  companies,  mutual,  176 


Jewelry,  tax  on,  483,  489 

Joint-stock  companies,  165;  Capital 
Stock  tax  on,  348,  382  (see  Massa- 
chusetts Trusts) 


Labor,  cost  of,  as  a  deduction,  142 

Labor  unions,  173 

Land,  no  depreciation  admitted,  226 

Land  banks  exempt,  177 

Landlord's  expenses  deductible,  106 

Legacies  and  gifts,  41,  144 

Legal  advisory  board,  17 

Lessee  corporations,  191 

Lessor  corporations,  170 

Liability  for  filing  return,  141 

Liberty  Loan  bonds,  income  from, 
42,  109,  130,  192 

License  for  collecting  foreign  in- 
come, 279 

Life  insurance  companies,  191 


Life  insurance  policies,  premiums 
on,  106,  107,  201,  213,  339;  pro- 
ceeds from,  40,  200,  300;  tax  on, 
587 

Life  of  asset,  224;  chart,  225 

Limited  partnerships,  79,  165 

Liquors,  tax  on,  493 

Live-stock,  cost  of,  108 

Loans  to  stockholders,  253 

Losses  in  business,  113,  301,  304; 
other  than  business,  117;  by 
theft,  115;  fire,  crops,  accident, 
116;  live-stock,  108;  bad  debts, 
120;  mortgage  foreclosure,  122; 
bonds,  122;  depreciation  and  de- 
pletion, 217;  sale  of  bonds,  218; 
real  estate,  219;  stock  transac- 
tions, 219;  classes  deductible,  217 


Magazines  and  books,  when  cost  is 
deductible,  105 

Manufacturer,  defined,  435,  480 

Manufacturing  corporation,  inven- 
tories of,  187 

Market  value,  inventory  at,  184,  188 

Maryland  Casualty  Co.  vs.  U.  S., 
243 

Massachusetts  Trusts,  165,  351 

McCoach  vs.  Ins.  Co.  of  North 
America,  243 

Medicinal  preparations,  tax  on,  485, 
480 

Membership   dues,    105 

Mercantile  corporation,  valuation 
of  stock,  365 

Mineral  waters,  tax  on,  518 

Mines,  depletion  of,  233,  302 

Mining  corporation,  valuation  of 
stock,  365 

Minors,  127,  128,  281,  285,  288 

Mortgage  foreclosure  losses,  122 

Motor  boats,  tax  on,  439 

Motor  vehicles,  481,  488 

Moving  picture  films,  tax  on,  483, 
488 

Munition  Manufacturer's  Tax,  434, 
451 ;  manufacturer  defined,  435; 
time  when  effective,  434,  452,  457; 
basis  of  tax,  435;  rate  of  tax,  435, 
452;  computation,  436;  articles 
taxable,  436,  451;  part,  defined, 
437;  net  income,  how  determined, 
440;  gross  income,  440;  deductions 
allowable,  442,  452 ;  raw  materials, 
442;  expenses  deductible,  443; 
returns,  448,  453;  assessment  and 
payment,  448,  454 ;  penalties,  449, 
455;  expiration  of,  637 


726 


INDEX 


Munitions,  articles   classed  as,  437- 

439,  451 
Musical    instruments,    482;    tax   on, 

488 
Mutual    fire     insurance     companies, 

190;  marine,  190 
Mutual  insurance  companies,  176 
Mutual  savings  banks,  173 

Net  estate,  defined,  391,  424 
Net  income,  37,  145,  146,  147,  151; 
deductions    allowable    in    comput- 
ing, 99;  under  Excess  Profits  tax, 
700;    general   provisions,    708;    of 
corporations,  706;  of  partnerships, 
707;  of  individuals,  708 
Nipissing  Mines  Co.  decision,  359 
Nominal  capital,  147;   defined,  718; 
determination  of  tax  on,  695;  rate 
of   tax   on   business   having,    635; 
distinguished   from   invested   cap- 
ital, 646 
Non-resident  aliens,  returns  by,  33, 
37,    44;    deductions,    100;    distin- 
guished   from    citizens,    101;    con- 
tributions to  charitable  organiza- 
tions,  113;   liability  to  tax,   126; 
withholding    against    individuals, 
259;  corporations,  260 
Normal  tax,  calculation  of,  158 
Notes,  promissory,  tax  on,  557,  572 
Notice,  of  assessment,  25 

Obsolescence,  224;  in  computation  of 
invested  capital,  710 

Occupational  Tax,  458;  persons  lia- 
ble to,  458;  exemptions.  466;  to- 
bacco manufacturers,  467-470; 
penalties,  470,  474 

Oil  pipe  lines,  tax  on,  586 

Oil  wells,  depletion  of,  237 

Operations,  income  from,  181 

Organization  expenses,  214 

Organizations,   charitable,   113 

Overhead,  188 

Parcel  post  packages,  tax  on,   561, 

574 
Parent  companies,  166-168 
Partial  payments  of  tax,  161 
Partners,  returns  of  individual,  308 
Partnership   Excess  Profits  tax,  de- 
ductible from  Income  tax  paid  by 
members,  697 
Partnerships,   income   from,   57,   71; 
interest  on  Liberty  bonds,  73;  lim- 
ited, 79;  deductions,  132,  145;  fis- 
cal year  of,  132,  309;   subject  to 
Munitions  tax,  434;  Excess  Profits 
tax,  636,  707 


Patent  rights,  76,  192,  230,  714 

Pawnbrokers,  tax  on,  461,  471 

Payment  of  tax,  160;  in  advance, 
161;  with  Treasury  certificates, 
checks,  346;  refund,  327 

Penalties  for  negligence  and  for 
fraud,  22-24,  333 

Pensions,  77,  210 

Perfumes,  tax  on,  485 

Personal  expenses,  not  deductible, 
103 

Philippine  and  Porto  Kican  resi- 
dents, 21,  126,  335,  345 

Piano  players,  tax  on,  482 

Playing  cards,  tax  on,  559,  573 

Political  sub-division,  defined,  41; 
taxability  of  interest  on  mort- 
gages of,  42 

Porto  Eico  and  Philippines,  taxes  in, 
21,  126,  335,  345 

Powers  of  attorney,  tax  on,  559,  573 

Preferred  stock,  valuation  of,  374 

Premium  paid  on  bonds,  69 

Premiums,   insurance,   105 

Prepaid  expenses,  207 

Prepayment  of  taxes,  345 

Pre-war  income  of  non-resident 
aliens,  656;  of  partnerships,  657; 
of  domestic  corporations,  657;  of 
foreign  corporations,  658 

Pre-war  period,  626,  631,  704;  in- 
come of,  653;  when  citizen  or  resi- 
dent not  then  engaged  in  business, 
655;  where  income  cannot  be  de- 
termined, 655 

Private  banks,  171 

Produce  sales  on  exchanges,  520,  571 

Professional  and  vocational  fees,  52 

Profit,  gross,  53;  from  property  ac- 
quired by  gift,  64;  from  partner- 
ships, 71;  from  sale  of  property, 
59,  204;  not  used  in  business,  ad- 
ditional tax  on,  252;  not  dis- 
tributed or  used  in  business,  299; 
averaged,  for  Excess  Profits  tax, 
686 

Promissory  notes,  tax  on,  557,  572 

Property,  bequeathed,  41;  deprecia- 
tion on,  122;  leased  by  corpora- 
tions, 170;  repairs  to,  221;  pur- 
chased for  capital  stock,  205 

Proxies,  tax  on,  559 

Public  exhibitions,  tax  on,  465,  473 

Public   utilities   and   insurance   tax, 

575 
Public  utility  corporations.   178 
Public  utility  earnings,  216;  valua- 
tion, 365 
Pullman  tickets,  tax  on,  583,  591 


INDEX 


727 


Bacing  associations,  tax  on,  603 

Badio  messages,  tax  on,  586 

Bate  of  tax,  1916  law,  normal,  127; 
deductions  from  normal  tax,  127; 
super- tax,  129;  1917  law,  131; 
table  of  additional  rates,  131; 
chart  of  rates,  133-137,  160;  of  in- 
come tax,  252;  additional  war  tax, 
341;  Excess  Profits  tax,  693 

Eaw  materials,  187 

Eeal  estate,  profits,  59,  143;  losses, 
219;  agents'  commissions,  106; 
conveyances  of  tax  on,  558 

Eealty  corporations,  177 

Eeceiver,  defined,  282,  352 

Eectified  spirits  and  wines,  tax  on, 
513 

Eedemption  of  unused  stamps,  508, 
562 

Eefund,  27;  of  stock  dividend  taxes, 
98;  of  tax  withheld  in  1907,  340 

Eegistered  bonds,  withholding  pro- 
vision, 264  ff. 

Eegulations,  Excess  Profits,   699 

Eelease  of  tax  withheld  at  source, 
276 

Eeligious  and  charitable  associa- 
tions, 175 

Eenewals,  221 

Eent,  defined,  66;  when  reportable, 
66;  in  considerations  other  than 
cash,  66;  paid  in  improvements  to 
property,  67;  in  crop  shares,  65; 
of  rooms  used  for  business,  104; 
of  residence  not  deductible,  112 

Eentals,  classified,  215 

Eents,  royalties  and  interest,  191 

Eeorganized  business,  deemed  con- 
tinuous, 629 

Eepairs,  123,  213;  defined,  221 

Eeserved  seats,  tax  on,  607 

Eeserves,  dividends  from,  80;  for 
losses,  220,  323 

Eesidence,  defined,  36;  legal,  139; 
taxes  on,  111 

Eeturns,  failure  to  file,  22;  access 
to,  29;  by  whom  filed,  32,  38; 
auditing  of,  26,  181,  329',  of  infor- 
mation, 277,  718;  of  withholding 
corporations,  275 

Eesidual  value,  223 

Eevaluation  of  assets,  80 

Eights  to  subscribe,  63 

Eoyalties,  patent  rights,  etc.,  76,  191 

"Bulings,"  "Eegulations,"  "De- 
cisions," etc.,  defined,  19,  20 


Salaries,     wages    and     commissions, 
48,  142,  208 


Salary,  when  deductible,  under  Ex- 
cess Profits  tax,  659;  paid  to  part- 
ners, 707;  paid  to  self,  709;  when 
treated  as  dividends,  210;  of  sol- 
diers, 210 

Sales,  yearly,  182 

Salesmen's  "treating  money,"  212 

Scrip  dividends,  82 

Season  tickets,  600 

Second  Liberty  Loan  bonds,  192 

Securities,  profits  from  sale  of,  64; 
left  by  decedent,  64;  dealers  in, 
115;  issued  for  mixed  tangible 
and  intangible  property,  714 

Separate  returns,  by  married  per- 
sons, 719 

Servants'  wages,  104 

Ship  brokers,  tax  on,  461,  471 

Sinking  fund,  interest  on,  194;  de- 
preciation, 228 

Specific  exemptions  (normal  tax), 
127 

Source,  withholding,  deduction  and 
information  at,  258 

"Sources  within  U.  S.,"  defined,  44, 
58,  101 

S.  P.  E.E,  vs.  Lowe,  196 

Spirits,  wine,  497;  distilled,  509', 
floor  tax  on,  512 

Sporting  goods,  tax  on,  485,  489 

Stamp  taxes,  520,  564;  documents 
taxable,  520;   Schedule  A,  568 

Stamps,  sale  of,  542;  requisitions 
for,  542;  redemption  of,  562;  pen- 
alties for  fraudulent  use  of,  563, 
565 

State  officers  and  employees,  43 

State  profits  from  public  utilities 
exempt,  179 

Stock  brokers,   registration   of,   530 

Stock  dividends,  87,  156;  double  tax- 
ation of,  88;  under  1913  law, 
Towne  vs.  Eisner,  88;  taxable  un- 
der present  laws,  91;  "Times" 
editorial  on,  92 

Stockholders'  salaries,  209 

"Stock  in  trade"  inventoried,  184 

Stock  returned  to  corporation,  713; 
tax  on  issue,  sale  or  transfer  of, 
525 

Stock  transactions,  profits  from,  60; 
losses  in,  114,  120,  219 

Submarines,  taxable,  439 

Subnormal  income,  692 

Subsidiaries,  166-168,  195,  374 

Suit  for  refund,  28 

Super-tax,  129,  130;  calculation,  153; 
chart,  154 

Supplemental  statement,  tax-exempt 
securities,  193 


728 


INDEX 


Surplus,  dividends  from,  80;  when 
earned,  197;  earned  prior  to  1913, 
82;  included  in  invested  capital, 
715 

Surplus  account,  adjustment  of,  un- 
der Excess  Profits  tax,  672 


Tangible  property,  adjustment  of 
shares  of  stock  issued  for,  669, 
670;  valuation  of,  685;  defined, 
711 

Taxable  year  defined,  625,  653;  net 
income  during,  of  individuals,  658; 
partnerships,  661;  corporations, 
662 

Tax-free  covenant  bonds,  151;  with- 
holding provisions,  266 

Taxes,  deductible,  110,  250,  304,  320; 
State  taxes,  251;  prepaid  taxes, 
207,  251;  paid  by  banks  for  stock- 
holders, 112,  251;  on  tax-free 
covenant  bonds,  251,  711 

Telegraph  messages,  tax  on,  586 

Telephone  companies,  mutual,  176 

Telephone  messages,  tax  on,  586 

Temporary  bonds,  523 

Tenant,  betterments  made  by,  66, 
67,  216 

Tentative  returns,  257 

Theaters,  tax  on  admission  to,  599; 
on  proprietors  of,  462,  472 

Theft,  losses  from,  115 

Thirty-day  notice,  405 

Tickets,  foreign  passage,  559,  573 

Timber  land,  depletion  of,  241 

Time  policies  of  insurance,  201 

Tobacco  manufacturers,  tax  on,  467- 
470,  U73 

Toilet  articles,  tax  on,  485,  489 

Towne  vs.  Eisner,  89-91 

Trade,  defined,  114,  699;  losses  in, 
114,  115;  income  from,  52 

Transaction,  closed  or  completed, 
63;  entered  into  for  profit,  117, 
700 


Transportation,  tax  on,  575,  582,  590 

Traveling  expenses,  50 

Total  net  income,  151 

Treasury  certificates,  in  tax  pay- 
ment, 346 

Treasury  decisions,  etc.,  defined,  19, 
20 

Trustee,  defined,  281 

Trust  estate,  income  of,  285 


Uncompleted  contracts,  189 
Undistributed   profits,    tax   on,    252, 

299,  314 
United  States,  defined,  21,  36 


Valuation,  inventory,  187;  of  stock, 
361 

Value  as  of  March  1,  1913,  how  de- 
termined, 64 


Wages,  servants',  104 

War  Estate  tax,  430;  rate,  431 

War  Excess  Profits  tax,  625,  639; 
Regulations  No.  41,  699 

War  Excise  taxes,  477;  articles  tax- 
able, 478;  by  whom  paid,  480;  re- 
turns, 480,  486;  penalties,  487 

War  Income  Tax,  341;  on  corpora- 
tions, 344 

"Weighted  year"  method,  deprecia- 
tion, 226 

Wine,  tax  on,  493 

Withholding  at  the  source,  258,  310, 
326;  fiduciaries,  293;  rate  of  tax 
withheld  (chart),  261;  refund  of 
tax  withheld,  263;  tax  on  bond  in- 
terest withheld,  264  ff. 

Worthless  stock,  losses  from,  114 


Yachts,  tax  on,  487,  491 
Yield  of  war  taxes,  13 


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